After 15 years of marriage, Art and Wanda were getting divorced. Among all the assets that had to be distributed was the family business, a heating, ventilation and air conditioning repair company. Husband was the operator of the business. Wife took care of the kids and managed the household. Now Husband was faced with having to pay Wife 50% of the value of the business.
Husband hired his own business appraiser to value the business. Wife hired her own appraiser as well. Husband’s appraiser valued the business at $500,000, and then took a discount off this amount for lack of marketability of 20%, or $100,000, for a “net” valuation amount of $400,000. Husband estimated that wife would get 50% of this amount, or $200,000, as her share of the business value settlement.
Wife’s appraiser used a beginning valuation amount for the business of $475,00, and came up with a “net” valuation amount of $475,000. Husband was beside himself. If the judge honed in on Wife’s valuation amount, Husband would have to pay her 50% of the $475,000, or $237,500. How could Wife’s appraiser start out with a lower valuation number and end up with a net valuation amount that was higher than the value determined by Husband’s appraiser?
The International Glossary of Business Valuation Terms defines Discount for Lack of Marketability as “an amount or percentage deducted from the value of an ownership interest to reflect the relative absence of marketability.” In other words, Husband’s appraiser decided that Husband could not take his business’ ownership interest to his local stockbroker and ask him to trade the business overnight – just like he could do with the Ford Motor Corp. stock he owned. This inability to quickly sell the ownership in the company was worth at least a discount of 20% in the mind of Husband’s business appraiser.
On the other hand, Wife’s appraiser decided that it would be unfair to saddle Wife’s interest with a discount of 20%, since Husband would continue running the business the very next day after the divorce was final. After all, discounts for lack of marketability were really only applicable to valuations done under the standard of Fair Market Value, which is “the price, expressed in terms of cash equivalents, at which property would change hands between a hypothetical willing and able buyer and a hypothetical willing and able seller, acting at arm’s length in an open and unrestricted market, when neither is under compulsion to buy or sell and when both have reasonable knowledge of the relevant facts.”
Wife’s appraiser also believed that Wife’s position was no different than that of a dissenting shareholder in a litigation action. Some states’ courts do not assess a discount for lack of marketability in dissenting shareholder litigation actions because the shareholder is being forced out of the company and has no say in whether his ownership interest stays unsold. Wife’s appraiser determined that not applying a discount for lack of marketability was really a Fair Value calculation similar to the standard of value used in dissenting shareholder cases.
I have found that in family law business valuation cases, Superior Court judges in Maricopa County, Arizona are leaning more and more to marital dissolution business valuations that do not include discounts for lack of marketability.
If you are a party to a marital dissolution business valuation, it is important for you and your attorney to know how your appraiser will be valuing the subject business: with or without a discount for lack of marketability. It could have a significant impact on the amount of your ownership interest to be paid to you; or, the amount you have to pay, depending on which party you are in the divorce action.
Don Bays, CPA/ABV, CVA, CFF