Russell v. Russell, 2013 Ark. App. LEXIS 151 (Feb. 27, 2013)
The husband challenged the trial court’s valuation of a family business, claiming there was no credible evidence to show it had a “fair market value” independent of the company’s founder—his stepfather.
At divorce, the husband and wife agreed on the division of all property but disagreed about the value of his one-third interest in his stepfather’s business, which he acquired during the marriage.
Both sides presented expert testimony, and both experts agreed that the value of 100% of the company was $3 million, but their computations of the value of the husband’s interest differed greatly.
In a pretrial deposition, the wife’s expert, a CPA, issued a disclaimer: His valuation did not follow the industry standard or his own practice; he intended it only for himself and his client, not for third parties. Normally, he would discuss general economic conditions, industry-specific and company-specific risks, a standard value for the shares, and goodwill. Here, he did none of these things because he had agreed with the wife what numbers and discounts to apply.
He said he “dropped the Mergerstat average control premium of 29.6% to 10%,” reasoning that the husband had some control over cash flow but admitting that a willing buyer of his shares might not think that control followed the purchase and may discount the value by 50%. He applied a 5% marketability discount even though he agreed that a buyer might aim for a much higher rate, between 30% and 40%.
Later, in his trial testimony, he said he discounted the company’s value by 10%. Since the husband and his two brothers, who each also owned one-third of the shares, could take money out of the company, they all had a degree of control. Although he recognized that the average marketability discount was 35%, he did not apply any. “Marketability and lack of control are not distinguishable,” he stated.
To account for the risks related to the possible sale of the company’s only client, he further discounted the value by 6%, a rate he thought was high. He relied on the wife’s statements that the company had retained the client despite several earlier changes in ownership and that, to her, meeting the client’s requirements “was extremely important and outweighed any personal relationship.” Similarly, the husband had stated the client seemed to like the company because it could adjust to changes more quickly than competitors.
Because the stepfather no longer owned the business, the wife’s expert did not discount for the founder’s personal goodwill.
The husband’s expert, a CPA, prepared a fair market valuation that complied with industry standards. Because the company was a going concern and he could not find comparable businesses, he used an income approach. Assuming a total value of $3 million, the husband’s interest was $1 million. He also thought that the company’s only client might be downsizing due to changes in ownership. The expert applied a 30% discount for lack of control and a 35% discount for lack of marketability, reducing the value to $458,000, half of which—$229,000—belonged to the wife.
He then discounted the goodwill of the company, assuming the enterprise goodwill was 50% and the personal goodwill attributed to the stepfather was 50%. The total value of the wife’s share was no more than $115,000, he concluded. The expert’s goodwill determination assumed that the stepfather remained with the company.
The trial court found that the stepfather was the company’s owner of record, but the husband and his brothers all owned an equitable interest in the business. It determined that, based on all evidence, the wife’s interest in the business was worth $273,000. In a motion for a new trial, which the court denied, the husband objected that the order included pay for nonmarital personal goodwill.
The husband then challenged the decision at the Arkansas Court of Appeals. The wife failed to prove that the company had fair market value independent of the founder’s goodwill, he argued. Specifically, the trial court’s valuation rested on “questionable” expert opinion.
The appellate court acknowledged that the lower court knew that the expert, rather than following industry standards, used discounts pursuant to his agreement with the wife. But, the reviewing court said, both experts agreed on the value of 100% of the company. Also, other competent evidence supported the trial court’s valuation. For example, it heard about the wife’s commitment to meeting the business needs of the firm’s only client and the husband’s belief that the client liked the firm.
Further, the husband failed to present evidence that might lower the value of the company, including proof that the client had reduced the assignments it gave to the firm or that it was downsizing, as his expert claimed. The Court of Appeals upheld the trial court’s award to the wife.