Business valuation basics in divorce-concentration on Tennessee case law.

1. What Family Lawyers Need to Know
About Business Valuations in Divorce
Presented by:
Robert Vance, CPA, ABV, CFF, CVA,
CFP
Forensic & Valuation Services, PLC
901-507-9173
www.ForensicVal.com
rvance@ForensicVal.com

2. What is the Essence of a Business Valuation?
It‟s a formula – right?

4. What is the Essence of a Business Valuation?
Estimation of two primary components
1) The future expected benefits
2) The risk related to receiving those future expected
benefits
A valuation measures the:
Present Value of the future benefits (e.g. The Time
Value of Money; a dollar today is worth more than
a dollar in one year)
A business is only really worth the present value
of the cash flow over and above a “normal”
owner compensation

5. What are the Standards of Value?
Fair Market Value
Fair Value
Investment Value
Intrinsic (Fundamental) Value
Book Value
Divorce Value?

6. Fair Market Value
Definition per IRS Revenue Ruling 59-60
“The price at which a property would change
hands between a willing buyer and a willing
seller when the former is not under any
compulsion to buy and the latter is not under any
compulsion to sell and both parties have
reasonable knowledge of the relevant facts.”

7. Fair Market Value
Powell v. Powell1
1) Fair Market Value Standard as in IRS Rev. Rul. 59-
60 does not have to be strictly followed when
valuing a business in a divorce
2) Business owners can be held to values in personal
financial statements submitted to banks
3) Credentials and experience of business valuation
analysts are critical
1. Powell v. Powell, 124 S.W.3d 100 (Tn. Ct. App. 2003)

8. What are the Approaches to Valuation?
Blasingame v. American Materials, Inc.2
“There are a number of acceptable methods available to
determine the value of a corporation.” Blasingame
recognized three of these methods [approaches]:
1) Market Value [approach],
2) Asset Value [approach], and
3) Earnings Value or Capitalization of Earnings
[Income] [approach]
2. Blasingame v. American Materials, Inc., 654 S.W.2d 659, (Tenn. 1983)

9. What are the Approaches to Valuation?
1) Market Approach
a) Expected benefit = some level of earnings (reve-
nue, net income, EBITDA, gross profit, etc.)
b) Expected risk and growth are measured by a
market multiple (P/E, MVIC/EBITDA, etc.)
c) Market multiples are obtained from public com-
panies, from sales of similar companies, or prior
sale of the subject company or interests in the
subject company

10. Market Transaction Method Using The Goodwill Registry
Total Value
Gross Revenues-2010 900,000 Estimate for 2011
Goodwill Registry Average Price/Rev %-General Dentistry 65.1% Average
Indicated Selling Price - Includes Equipment 585,900
Adjusted Net Operating Assets 158,660 Cash, A/R, Payables
L-T Debt (213,348)
531,212
Non-Operating Assets
Destin Condo 450,000
Excess Cash 10,000
Residential Lot 15,000 475,000
Indicated Total Value, Net of Debt 1,006,212
Indicated Total Value, Net of Debt (Original) 1,006,212
Total Goodwill Value
Gross Revenues-2010 900,000
Goodwill Registry Average GW/Gross Revenues %-General Dentistry 49.0%
Indicated Goodwill Included in Selling Price 441,000
* General Dentistry; Year 2010; The Health Care Group, Inc.
Beware of this value as it may or may not include Goodwill and may not include
all assets like cash and liabilities like A/P

11. What are the Approaches to Valuation?
2) Asset Approach
Adjusted Net Book Value method is similar to the
classic accounting formula:
Assets - Liabilities = Equity
or
Identifiable “Hard”* Assets Adjusted to FMV –
Liabilities = Value
* “Hard Assets”: Cash, A/R, N/R, WIP, Patient
Records, Equipment, Purchased Goodwill, etc.

12. Adjusted Net Asset Value Method
3/31/2011 3/31/2011
Bal. Sheet Adjustments Bal. Sheet
Cash 98,408 98,408
Accounts Receivable 63,215 (20,000) 1) 43,215
Accounts Payable & Other (2,963) (2,963)
Adjusted Net Operating Assets 158,660 138,660
Dental Equipment (Depreciated) 50,000 150,000 2) 200,000
Non-operating Assets 0 475,000 3) 475,000
Total Asset Value 208,660 813,660
L-T Debt (213,348) (213,348)
Indicated Value, Net of Debt (4,688) 600,312
1) Insurance company discount - A/R recorded at gross before discounts
2) Appraisal of dental equipment by personal property appraiser
3) Appraisal of other assets by personal property appraiser & real estate appraiser

13. What are the Approaches to Valuation?
3) Income Approach
a) Expected benefit = net cash flow or other
measure of:
 Forecasted benefits
 Normalized historical benefits
b) Expected risk is measured by the weighted
average cost of capital, capitalization rate or
discount rate
c) Net present value of expected benefit

14. Capitalization Of Earnings Capitalization Rate
Risk-free Rate of Return 4.5% 5 Year Average of 20 Yr Bond rate
Common Stock Equity Risk Premium 6.5% Morningstar, Ibbotson SBBI 2010 Valuation Yearbook
Small Stock Risk Premium 10.5% Morningstar, Ibbotson SBBI 2010 Valuation Yearbook
Company Specific Premium 6.5% Independent Analysis
Net discount rate 28.0%
Less Sustainable Growth 3.0% Independent Analysis
Next Year Capitalization Rate 25.0%

15. Capitalization Of Earnings Economic Stream
Dec Dec Dec Dec Dec
2011 2010 2009 2008 2007
Historic Net Income Using Sched. C as Basis 516,036 422,003 330,484 191,134 60,503
Depreciation 0 17,957 33,992 69,649 119,004
Mean Compensation for Independent Dentists* (211,006) (209,733) (208,468) (207,210) (205,960)
Adjusted Earnings Before Deprec. and Taxes 305,030 230,227 156,008 53,573 (26,453)
Weight 3 2 1 0 0
Stream Weight 915,091 460,454 156,008 0 0
Weighted Average 255,259
Less Ongoing Depreciation/Amort. (38,000)
Taxable Base 217,259
Less State Income Taxes 6.5% (14,122)
Sub-Total 231,381
Less Federal Taxes (73,489)
Sub-Total 157,892
Add Back Ongoing Depreciation/Amort. 38,000
Decrease/(Increase) in Working Capital (5,000)
Decrease/(Increase) in Capital Expenditures (38,000)
Ongoing Earning Capacity 152,892
* American Dental Association, 2009 Survey of Dental Practice; 2008-2006 reported; 2011-2009
calculated with trend %

16. Capitalization Of Earnings Indicated Value
Ongoing Capacity 152,892
Capitalization Rate 28.5% 1/.285 =
Operating Value 536,464 3.5 Multiple
Non-Operating Assets
Destin Condo 450,000
Excess Cash 10,000
Residential Lot 15,000 475,000
Indicated Value, Net of Debt 1,011,464
Indicated Value, Net of Debt (Original) 1,099,050

17. How is Personal Goodwill Handled in a Tennessee
Divorce?
Generally
1) Fair Market Value inherently includes Goodwill
when valuing with a going concern premise
2) Personal goodwill is generally not to be considered
in valuation of professional practices and
small, closely-held businesses primarily dependant
upon the individual for success
3) Courts often use a standard other than FMV

18. How is Personal Goodwill Handled in a Tennessee
Divorce?
Hazard v. Hazard3
1) Dr. Hazard‟s practice was highly specialized and
very dependent upon referrals from other physicians
2) Court rejected gross income approach to value
Husband‟s medical practice
3) Goodwill in a professional practice is not a marital
asset subject to equitable distribution
3. Hazard v. Hazard, 833 S.W.2d 911 (Tn. Ct. App. 1991)

19. How is Personal Goodwill Handled in a Tennessee
Divorce?
Hazard v. Hazard (cont’d)
4) Sole practitioner professional practice is to be
valued using the “net tangible assets with
ascertainable value.” Cites Smith v. Smith4
5) Net Asset Value a.k.a. Net Book Value
4. Smith v. Smith, 709 S.W.2d (Tn. Ct. App. 1985)

20. How is Enterprise/Business Goodwill Handled in a
Tennessee Divorce?
Witt v. Witt5
1) If the professional practice or closely-held business
is large and diverse enough and not solely dependent
on the individual, goodwill may be considered as
part of the ownership interest
2) Dr. Witt‟s clinic was found to have separate good-
will that was not directly related to his professional
or personal goodwill
5. Witt v. Witt, 17 TAM 15-6 (Tn. Ct. App. 1992)

21. How is Enterprise/Business Goodwill Handled in a
Tennessee Divorce?
Eberting v. Eberting6
1) Orthodontia practice value at FMV by Vance at
$700k; included Enterprise (not Personal) Goodwill
2) Opposing expert valued practice At $224k (net book
value with no Goodwill)
3) Trial judge found value to be $500k, which was a
value indicated by the owner; judge knew that any
value north of $224k was including Goodwill
6. 2012 WL605512

22. How is Enterprise/Business Goodwill Handled in a
Tennessee Divorce?
Eberting v. Eberting (cont’d)
4) “When asked if the amount of goodwill were
subtracted from his $700,000 if the resulting value
would be $270,000, Mr. Vance stated: „That‟s
correct, if you went with a net asset value method,
which of course is not the real value of this
company.” Mr. Vance also stated: “If you were to
strike the personal goodwill, this clearly has
enterprise goodwill associated with it. It‟s not all
personal to him.‟ ”

23. How is Enterprise/Business Goodwill Handled in a
Tennessee Divorce?
Eberting v. Eberting (cont’d)
5) “Husband argues on appeal that the value assigned
by Wife‟s expert, Mr. Vance, of $700,000 should
not have been accepted by the Trial Court because it
incorrectly included good will. We agree that
“professional good will is not a marital asset which
would be accounted for in making an equitable
distribution of the marital estate.” Smith v.
Smith, 709 S.W.2d 588, 592 (Tenn. Ct. App. 1985).”

24. How is Enterprise/Business Goodwill Handled in a
Tennessee Divorce?
Eberting v. Eberting (cont’d)
6) “A trial judge, as the fact finder, is not required to
check his or her common sense at the door when
considering evidence. The Trial Court had before it
evidence of values that Husband himself had
applied to his practice, and had Husband‟s own
testimony that he would be upset if he were to sell
the practice and receive only the value assigned by
his expert. The Trial Court found a value for the
practice that was within the range of values
presented by the evidence.” [emphasis added]

25. Multiattribute Utility Model (MUM)*
Importance Existence Mult.
Personal Goodwill Attributes Utility Utility Utility Percent
Ability, Skill & Judgment 1 4 4 16 9.2%
Lacks Transferability 2 5 0 0 0.0%
Age & Health 3 5 1 5 2.9%
Personal Staff 4 4 2 8 4.6%
Personal Reputation 5 4 3 12 6.9%
Personalized Name 6 4 3 12 6.9%
Marketing & Branding 7 2 2 4 2.3%
In-bound Personal Referrals 8 4 2 8 4.6%
Knowledge of End User/Customer 9 2 2 4 2.3%
Important Personal Nature 10 3 2 6 3.5%
Total Personal Utilities 37 21
Total Personal Multiplicative Utility 75 43.4%
Importance xistence
E Multiplicative
Enterprise Goodwill Attributes Utility Utility Utility Percent
Enterprise Staff 1 4 3 12 6.9%
Business Reputation 2 4 3 12 6.9%
Business Name 3 5 2 10 5.8%
Marketing & Branding 4 3 2 6 3.5%
Business Locations 5 4 3 12 6.9%
Years in Business 6 4 3 12 6.9%
Systems & Organization 7 3 2 6 3.5%
Out-bound Referrals 8 4 2 8 4.6%
Repeating Revenue Stream 9 5 4 20 11.6%
Total Enterprise Utilities 36 24
Total Enterprise Multiplicative Utility 98 56.6%
Total Multiplicative Utility 173 100.0%
*Wood, David, BVR‟s Guide to Personal v. Enterprise Goodwill, Business
Valuation Resources, LLC, Portland OR, 2010.

26. How are Buy-Sell Agreements Handled in a
Tennessee Divorce?
Harmon v. Harmon7
1) Dr. Harmon was a doc in a large medical practice
2) Buy-sell agreement contained an artificially low
value formula if a doc terminated
3) Buy-sell agreement of a closely-held corporation, not
signed by the non-shareholder spouse, is not binding
on that spouse and is only a consideration in the
valuation
7. Harmon v. Harmon, 25 TAM 15-22 (Tn. Ct. App. 2000)

27. How are Buy-Sell Agreements Handled in a
Tennessee Divorce?
Inzer v. Inzer8
1) Husband owned a 24% interest in a Sonic restaurant
and signed a buy/sell agreement with a low valuation
method
2) Wife, not an owner, signed an agreement stating she
agreed to be bound by the same terms
3) Court found that the value of the business should be
determined based upon the buy/sell agreement since
the wife had signed the agreement
8. Inzer v. Inzer, No. M2008-00222-COA-R3-CV July 28, 2009 (Tenn.Ct.App.
2009)

28. Financial Statement Adjustments
1) Adjustments for Generally Accepted
Accounting Principles (“GAAP”) departures
a) Year end accruals
b) Accelerated depreciation
c) Cash basis to accrual (inventory, accounts
receivable)
d) Prepaid assets
e) Intangibles (work in process, medical files)

29. Financial Statement Adjustments
2) Adjustments for Normalization
a) Personal expenses
b) Owner‟s salary
c) Non-operating assets
d) Shareholder loans
e) Nonrecurring income and expenses
f) Income taxes

30. Discounts & Premiums
1) Discount for Lack of Control (Minority Interest)
2) Premium for Control
3) Discount for Lack of Marketability
4) Discount for Key person
They depend on the interest to be valued and the
techniques used to establish the value conclusion

31. Discounts & Premiums
1) Discount for Lack of Control (Minority Interest)
Anderson v. Anderson9
“The reasons given by Warren to discount the value of
the husband‟s minority interest are persuasive, and the
evidence does not preponderate against discounting the
value by 38.3%.”
9. Anderson v. Anderson, 2006 WL 2535393, at*4

32. Discounts & Premiums
3) Discount for Lack of Marketability
Bertuca v. Bertuca10
“There is no indication in the record that Mr. Bertuca
has any intention of selling his interest in Capital Food
Services. Thus the value of the business is not affected
by the lack of marketability and discounting the value
for non-marketability in such a situation would be
improper.” Anderson, 2006 WL 2535393, at*4.
10. Bertuca v. Bertuca, 2007 WL 3379668 (Tenn.Ct.App.).