Sharp v. Sharp, 2013 Neb. App. LEXIS 58 (April 9, 2013)

DivorceOne of the principal issues in this divorce case was the trial court’s valuation of two medical practices in which the husband had varying interests. On appeal, the husband objected that one valuation wrongly included personal goodwill and the other a “mathematical error” as to the size of his interest.

The husband was a physician who practiced internal medicine through two venues. In the first, he was the sole shareholder of a company that contracted out his services as the medical director of a series of nursing homes and also contracted out his services to a concierge medical practice, in which members pay an annual fee, in addition to standard office visit fees, to ensure direct access to a doctor.

The second practice was more traditional. At incorporation in 2006, it had three partners, the husband included. In 2009, one of the original partners left. At trial, the husband initially stated a third partner joined in January 2010 but subsequently admitted the date actually was January 2011. A fourth partner came on board in January 2012. The husband also testified that, if he were to leave the business, he would only receive $15,000 for his interest based on the practice’s “stock restriction agreement.”

The parties’ experts both were CPAs and experienced business valuators and used a capitalization of earnings method to value the first practice. The wife’s expert noted that this method was one of three principal methods in business valuation. First, he determined that in this case it was reasonable to adjust officer’s compensation upwards, from the $60,552 the 2010 income statement listed to $100,000. When he subtracted that amount from the company’s earnings, he arrived at net earnings of $100,687. Applying a 26.52% capitalization rate, he obtained a “rounded” value of approximately $380,000.

Because he lacked information as to the business’s receivables and payables, he decided not to perform an asset-based valuation. This method was appropriate when a business had no established earnings history, a volatile earnings/cash flow history, or when it was questionable whether the company could continue without an infusion of additional cash or could be sold as an asset-based purchase, the expert explained.

Thus the husband’s 100% ownership interest in the first practice was worth $380,000, he concluded. He valued the second entity at $456,000 and concluded that, at the time he completed his report, in November 2011, the husband owned a one-half interest, yielding a value of $228,000.

In contrast, for the first practice, the husband’s expert arrived at a value of approximately $104,000. He set compensation at $176,000, maintaining that this figure reflected the payment an independent contractor received who performed services similar to the ones the husband provided. He admitted on cross-examination that, had he used the $100,000 compensation figure, his valuation would have increased by some $250,000.

He also performed a net asset valuation based on the company’s balance sheet for Dec. 31, 2011. This method, he decided, yielded a value of approximately $14,000. He concluded that the $90,000 difference in value resulting from his two valuations represented the market value of the business’s intangible assets, including goodwill. Up to 20% of this amount was business goodwill, and the remainder personal goodwill, he decided. His investigation into the practice indicated there was some personal goodwill “due to the age of the business and the way the accounts were held.” Excepting personal goodwill, the first practice was worth between $14,000 and $32,000.

He criticized the wife’s expert for using pre-income-tax earnings in his valuation and failing to adjust for fixed asset replacements and additions.

He valued the second practice as of Dec. 31, 2011, assuming a one-fourth ownership interest. The entity itself was worth $400,000, and the husband’s share $100,000.

At trial, the wife’s expert responded. He noted that the stark disparity between the valuations under the capitalization of earnings approach stemmed from disagreement over the husband’s compensation. The competing expert’s $176,000 adjustment was “questionable,” he said, because the business did not have enough cash “to pay that out” without borrowing. He thought the likelihood of this was small, and the husband admitted so.

Moreover, he pointed out, the first practice had a note payable for $88,000 from the husband, which his expert failed to consider in his valuation. Had the husband’s expert added this amount back into the adjusted net asset valuation, “the professional practice goodwill issues would have been eliminated,” the wife’s expert claimed. Given the wide yearly differences in past asset purchases, he said it was impossible to confirm that the opposing expert made a proper adjustment for fixed asset replacements. To justify the adjustment, more detail was necessary; at the same time, this adjustment changed the value of the business by $40,000.

The district court adopted the valuations the wife’s expert proposed for both businesses. But for the second practice, it determined that the husband possessed a one-third, not a one-half, interest. Therefore, based on the $456,000 valuation the wife’s expert provided for the entity, the husband’s interest was worth $152,000.

Conflicting testimony on partnership interest.

The husband appealed to the Nebraska Court of Appeals as to both valuations.

Goodwill. Interms of the first practice, he claimed the trial court erred when it credited the conclusions of the wife’s expert because the valuation included personal goodwill. Specifically, considering he was the sole shareholder, all income the first practice generated was the result of his own labor and the wife’s expert simply valued his future labor.

In support, he cited precedent in which a wife’s expert had used a “capitalization of excess earnings” approach to value the two practices in which the spouse was the sole shareholder. In that case, the district court rejected the valuation, and the state Supreme Court ultimately affirmed. The high court decided that, for goodwill to qualify as a divisible asset in a divorce case, it had to be a “business asset with value independent of the presence or reputation of a particular individual, an asset which may be sold, transferred, conveyed, or pledged.” In contrast, goodwill that depended on the continued presence of a particular individual was not a marital asset. Further, the court made it clear it did not reject categorically the capitalization of excess earnings as a method to determine earning capacity. See Taylor v. Taylor, 386 N.W.2d 851 (1986) (available at BVLaw).

The appellate court here rejected the argument. This case, it said with emphasis, was not similar to the cited case because here the wife’s expert did not use a capitalization of excess earnings method; he also did not determine a value in the form of goodwill based on the husband’s presence or reputation. Instead, he used a capitalization of earnings approach based on the practice’s actual earnings, albeit with an adjustment for reasonable compensation. The husband’s expert used the same approach but chose a higher amount of compensation. The wife’s expert plausibly explained that what the husband’s expert designated as “goodwill”—the difference between the capitalization of earnings value and the adjusted net asset value—would not be there if he properly had addressed a note receivable.

Mathematical error. The husband did not challenge the district court’s accepting the $456,000 value the wife’s expert determined for the second business. But he claimed he only had a one-fourth interest at the time of trial. The trial court should have used that date and size of partnership interest.

Again, the reviewing court disagreed. The record showed that the husband had given confusing testimony as to when the third and fourth partner joined the practice. He admitted that he only had a one-third interest as of Dec. 31, 2011, the date when his own expert valued this practice. There was no mathematical error, the appellate court stated, adding, “for the sake of completion,” that the district court did not abuse its discretion when it decided to value the business before the fourth partner joined.