'The Continuum of Value'

These states reach such different conclusions as to what constitutes marital property because they have different views as to the meaning of the term 'value.' Florida and Washington, along with other states, view marital property through the prism of what it might fetch if sold. On the other hand, other states view value more in the context of what it is worth to the owner, or in this instance, the marital estate.

From the perspective of a valuation professional, these concepts are captured in the underlying premise of value and the standard of value employed in a valuation. Two experts performing their work in an unbiased fashion can reach totally different conclusions if they use a different premise of value or standard of value. Throughout the United States, the premise of value and standards of value vary greatly as illustrated by the above examples. We conducted a comprehensive review of the premises and standards of value used in different contexts. This article represents a summary of some of our findings concerning the application of the premises and standards of value in divorce matters.

In performing our research for the standards of value, we examined the equitable distribution or community property statutes of all 50 states and the District of Columbia, judicial opinions that address the standard of value, scholarly articles and other sources. We found that courts have generally reached their conclusions of value by employing one of the overreaching premises of value: value in exchange and value to the holder. Value in exchange is the value of the business, or business interest, in a real or a hypothetical sale. The value to the holder premise represents the value of a property that is not being sold, but instead is being maintained in its present form by its present owner.

We also found that states generally follow three standards of value.

Fair Market Value

As used in estate and gift taxes, fair market value is defined as:

the price, expressed in terms of cash equivalence, 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. http://bvfls.aicpa.org/Resources/Business+Valuation/Tools+and+Aids/Definitions+and+Terms/International+Glossary+of+Business+Valuation+Terms.htm..

Fair market value, as explained above, is a value in exchange. It implies a real or hypothetical sale. Consequently, only assets that can be sold are valued under the FMV standard. This is an important concept that we will discuss later.

Fair Value

As defined in shareholder oppression and dissenters' matters, fair value as used in oppression and dissenter's rights cases is not explicitly defined as is Fair Market Value. It is defined in dissenters' statutes in most states. It has also been defined by the American Bar Association's Model Corporate Business Act and later the revised Model Corporate Business Act, and by the American Law Institute's Principles of Corporate Governance. The most recent definition of the revised Model Corporate Business Act in 1999 essentially states that there will be no discounts for minority status, no discount for lack of marketability (after an extraordinary circumstance) and that the valuation will be performed using customary and current valuation concepts and techniques employed for similar businesses. Generally fair value is viewed as a value in exchange determined as pro rata share of the value of the enterprise without regard to minority status or lack of marketability; however, fair value can at times be interpreted as a value to the holder.

Investment Value

In matrimonial matters, investment value does not presume a sale, and is a value to the holder. Investment value is often viewed as the value to a specific buyer (the owner) as opposed to a hypothetical buyer. In a matrimonial proceeding, the value to the holder premise values the business or business interest in the hands of the spouse who retains ownership of the business. This assumption is important because the difference between fair market value and investment value is that fair market value is a valuation based upon a sale. As we explain later, our review led us to conclude that there is what we call a continuum of value which extends from fair market value under the value in exchange premise to investment value under the value to the holder premise.

Analysis

When we examined the statutes of all 50 states, we found that only Arkansas and Louisiana explicitly provide guidance as to the standard of value to be used in matrimonial dissolution. Arkansas directs that securities be valued under the fair market value standard and Louisiana holds that assets be valued under fair market value. For each other state we examined case law to find guidance. In 10 other states we found case law that directs courts to apply fair market value when valuing a business. For instance, in a 1988 Hawaii case, Antolik v. Harvey, 7 Haw. App. 313; 716 P.2d 305(1998), the court found as follows:

When dividing and distributing the value of the property of the parties in a divorce case, the relevant value is, as a general rule, the fair market value (FMV) of the parties' interest therein on the relevant date. We define the FMV as being the amount at which an item would change hands from a willing seller to a willing buyer, neither being under any compulsion to buy or sell and both having reasonable knowledge of the relevant facts.

The remaining 39 states and the District of Columbia did not provide such clear guidance; therefore, we looked to three elements in order to determine the manner in which to classify each state's implied Standard of Value: treatment of personal or enterprise goodwill, the application of shareholder level discounts, and the weight accorded buy/sell agreements.

Personal Versus Enterprise Goodwill

Goodwill is the expectancy of repeat patronage and the expected profits that come from that patronage. Enterprise goodwill is goodwill that has attached to the business and is saleable. Personal goodwill, the goodwill associated with the person, generally is not marketable without the continued postmarital participation of that person. Alica Brokers Kelly, 'Sharing a Piece of the Future Post-Divorce: Toward a More Equitable Distribution of Professional Goodwill,' 51 Rutgers Law Review 569 (Spring 1999), at 588. Personal goodwill is the goodwill that arises from skill, reputation, relationships, and 'the book of business' of an individual.

The California case of Golden v. Golden, 270Cal.App.2d 401; 75Cal.Rptr. 735 (1969), pertains to a husband, a 31-year-old doctor, and his wife, a 29-year-old housewife. The trial court found that there was goodwill in the husband's medical practice. He appealed, saying that his goodwill could not be sold. In other words, there could be no value in exchange, no fair market value to his practice. The appellate court made the following comment:

' in a matrimonial matter, the practice of the sole practitioner husband will continue with the same intangible value as it had during the marriage. Under the principles of community property law, 'the wife, by virtue of her position of wife, made to that value the same contribution as does a wife to any of the husband's earnings and accumulations during the marriage. She is as much entitled to be recompensed for that contribution as if it were represented by the increased value of stock in a family business.

Thus, in this 1969 case, the California Appellate Court decided that the goodwill of the husband's medical practice should be divided as part of the marital estate even though it could not be sold.

Any state that valued personal goodwill followed an investment value standard and a value to the holder premise. If it allowed only enterprise goodwill, it followed a value in exchange premise and a fair market value or fair value standard.

Shareholder Level Discounts

Shareholder level discounts: In what we have characterized as a value in exchange state, the standard of value is usually viewed as between Fair Market Value and Fair Value. These standards of value assume some sort of transaction or exchange of the interest. It is widely acknowledged by valuation practitioners that a minority interest in a closely held business is typically not worth its proportionate share of the whole value of the entity.

Accordingly, when starting from the proportionate share of the whole value of the entity, a discount to reflect the minority status of the interest is applied, when appropriate. There can be a difference between fair market value and fair value concerning the treatment of discounts for minority status and lack of marketability. Under the fair market value premise, the exchange is of the individual interest at the shareholder level and, therefore, in estate and gift matter, minority and marketability discounts are considered, and, when appropriate, applied. Under the fair value premise in certain matters, the business is presumed to be sold with the shareholder receiving his proportionate share of the business value often without regard to discounts at the shareholder level. Hence discounts for minority and marketability are often not applied. The argument often made in matrimonial matters is that there is no intention to sell the business or a spouses' share of the business and therefore discounts as discussed above are not applicable.

This would imply a fair value or investment value standard. It should be remembered that under the fair market value standard, no actual sale need be contemplated. Fair market value assumes a hypothetical transaction between a hypothetical willing buyer and a hypothetical willing seller. Therefore the argument that the business or interest should be valued assuming no actual sale implies a standard of value different from fair market value. This is usually fair value (no shareholder level discounts), which assumes the sale of the whole company, or investment value, which assumes no sale at all.

In what we have characterized as a value-in-exchange state, the standard of value is usually viewed as between Fair Market Value and Fair Value. Under the fair market value premise, the ownership interest valued is that of the individual
and, therefore, minority and marketability discounts, which are properly considered in estate and gift tax matters, are taken. Under a fair value standard or an investment value standard, discounts are not taken.

Fair Value is typically expressed as a percentage of the whole without discounts. The argument commonly put forth in matrimonial matters is that the spouse is not intending to sell the business and, therefore, discounts are not applicable. This would imply a fair value standard. Remember, under a fair market value standard no sale need be contemplated. The transaction is a hypothetical transaction between a hypothetical willing buyer and a hypothetical willing seller. There is a methodology used to determine what the individual interest would be worth in a free and open market. A fair market valuation is often performed where no sale is contemplated. The use of minority and marketability discounts implies a fair market value standard as opposed to a fair value standard. The disallowance of minority and marketability discounts implies a fair value standard.

Buy/Sell Agreements

Buy/sell agreements are helpful to determine standard of value employed in a particular state due to the context in which the agreements are used. For instance, in Colorado, a state we believe is an investment value state, the court rejected a valuation based on the partnership agreement because the husband intended to stay with the firm. In re: Huff, 834 P2d 244 (Colo.1992). Since the argument put forth was that the stockholder agreement was not relevant because there was no intention to sell, the proper valuation should be in accordance with investment value because this standard allowed the court to determine the value of the partnership interest in use (a value-to-the-holder premise). In contrast, in Connecticut, a fair market value state, the court rejected the buy/sell agreement in Dahill v. Dahill, 1998 Conn. Super. LEXIS 846 (Conn. Super. Ct. Mar. 30 1998), because the buy/sell agreement did not provide for the fair market value of the business.

Conclusion

Through our analysis, we concluded that there is a continuum that begins with states that value only marketable enterprise goodwill, and ends with states that value personal goodwill on the other end of the continuum.

William J. Morrison is the President of Morrison & Company in Paramus, NJ, and can be reached at w.morrison @morrisoncpa.com. Jay E. Fishman is the Managing Director of Financial Research Associates in Bala Cynwyd, PA. He can be reached at Jfishman@ finresearch.com.

Despite no seeming fundamental economic differences, there have been occasions where divorce courts in different states have reached different conclusions of value for the same type of business. For example, the appellate courts in Washington and Colorado were asked to address the value of State Farm insurance agencies operating under the same agreement. In the Colorado case, In Re: Graff 902 P.2d 402 (Colo. Ct. App. 1994), the court ultimately settled on a value for the agency that included goodwill, while a Washington court limited the value of the agency to the hard assets. The same is true for sole proprietor attorneys. In Dugan v Dugan, the New Jersey Supreme Court found that the goodwill of a sole proprietor attorney could have value as a marital asset, even though he was ethically prohibited from selling his goodwill at that time. Taking the opposite view, the Florida Appellate Court in Thompson v Thompson, 576 So. 2d 267 (Fla. 1991), found that if Mr. Thompson could not sell the goodwill of his law practice, it had no value as a marital asset.

Could it be that State Farm agencies in Colorado are worth more than those operating in Washington, or that sole proprietors engaged in practicing law create more value in New Jersey than they do in Florida? We think not!

The 'Value' of Marital Property

These states reach such different conclusions as to what constitutes marital property because they have different views as to the meaning of the term 'value.' Florida and Washington, along with other states, view marital property through the prism of what it might fetch if sold. On the other hand, other states view value more in the context of what it is worth to the owner, or in this instance, the marital estate.

From the perspective of a valuation professional, these concepts are captured in the underlying premise of value and the standard of value employed in a valuation. Two experts performing their work in an unbiased fashion can reach totally different conclusions if they use a different premise of value or standard of value. Throughout the United States, the premise of value and standards of value vary greatly as illustrated by the above examples. We conducted a comprehensive review of the premises and standards of value used in different contexts. This article represents a summary of some of our findings concerning the application of the premises and standards of value in divorce matters.

In performing our research for the standards of value, we examined the equitable distribution or community property statutes of all 50 states and the District of Columbia, judicial opinions that address the standard of value, scholarly articles and other sources. We found that courts have generally reached their conclusions of value by employing one of the overreaching premises of value: value in exchange and value to the holder. Value in exchange is the value of the business, or business interest, in a real or a hypothetical sale. The value to the holder premise represents the value of a property that is not being sold, but instead is being maintained in its present form by its present owner.

We also found that states generally follow three standards of value.

Fair Market Value

As used in estate and gift taxes, fair market value is defined as:

the price, expressed in terms of cash equivalence, 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. http://bvfls.aicpa.org/Resources/Business+Valuation/Tools+and+Aids/Definitions+and+Terms/International+Glossary+of+Business+Valuation+Terms.htm..

Fair market value, as explained above, is a value in exchange. It implies a real or hypothetical sale. Consequently, only assets that can be sold are valued under the FMV standard. This is an important concept that we will discuss later.

Fair Value

As defined in shareholder oppression and dissenters' matters, fair value as used in oppression and dissenter's rights cases is not explicitly defined as is Fair Market Value. It is defined in dissenters' statutes in most states. It has also been defined by the American Bar Association's Model Corporate Business Act and later the revised Model Corporate Business Act, and by the American Law Institute's Principles of Corporate Governance. The most recent definition of the revised Model Corporate Business Act in 1999 essentially states that there will be no discounts for minority status, no discount for lack of marketability (after an extraordinary circumstance) and that the valuation will be performed using customary and current valuation concepts and techniques employed for similar businesses. Generally fair value is viewed as a value in exchange determined as pro rata share of the value of the enterprise without regard to minority status or lack of marketability; however, fair value can at times be interpreted as a value to the holder.

Investment Value

In matrimonial matters, investment value does not presume a sale, and is a value to the holder. Investment value is often viewed as the value to a specific buyer (the owner) as opposed to a hypothetical buyer. In a matrimonial proceeding, the value to the holder premise values the business or business interest in the hands of the spouse who retains ownership of the business. This assumption is important because the difference between fair market value and investment value is that fair market value is a valuation based upon a sale. As we explain later, our review led us to conclude that there is what we call a continuum of value which extends from fair market value under the value in exchange premise to investment value under the value to the holder premise.

Analysis

When we examined the statutes of all 50 states, we found that only Arkansas and Louisiana explicitly provide guidance as to the standard of value to be used in matrimonial dissolution. Arkansas directs that securities be valued under the fair market value standard and Louisiana holds that assets be valued under fair market value. For each other state we examined case law to find guidance. In 10 other states we found case law that directs courts to apply fair market value when valuing a business. For instance, in a 1988 Hawaii case, Antolik v. Harvey , 7 Haw. App. 313; 716 P.2d 305(1998), the court found as follows:

When dividing and distributing the value of the property of the parties in a divorce case, the relevant value is, as a general rule, the fair market value (FMV) of the parties' interest therein on the relevant date. We define the FMV as being the amount at which an item would change hands from a willing seller to a willing buyer, neither being under any compulsion to buy or sell and both having reasonable knowledge of the relevant facts.

The remaining 39 states and the District of Columbia did not provide such clear guidance; therefore, we looked to three elements in order to determine the manner in which to classify each state's implied Standard of Value: treatment of personal or enterprise goodwill, the application of shareholder level discounts, and the weight accorded buy/sell agreements.

Personal Versus Enterprise Goodwill

Goodwill is the expectancy of repeat patronage and the expected profits that come from that patronage. Enterprise goodwill is goodwill that has attached to the business and is saleable. Personal goodwill, the goodwill associated with the person, generally is not marketable without the continued postmarital participation of that person. Alica Brokers Kelly, 'Sharing a Piece of the Future Post-Divorce: Toward a More Equitable Distribution of Professional Goodwill,' 51 Rutgers Law Review 569 (Spring 1999), at 588. Personal goodwill is the goodwill that arises from skill, reputation, relationships, and 'the book of business' of an individual.

The California case of Golden v. Golden, 270Cal.App.2d 401; 75Cal.Rptr. 735 (1969), pertains to a husband, a 31-year-old doctor, and his wife, a 29-year-old housewife. The trial court found that there was goodwill in the husband's medical practice. He appealed, saying that his goodwill could not be sold. In other words, there could be no value in exchange, no fair market value to his practice. The appellate court made the following comment:

' in a matrimonial matter, the practice of the sole practitioner husband will continue with the same intangible value as it had during the marriage. Under the principles of community property law, 'the wife, by virtue of her position of wife, made to that value the same contribution as does a wife to any of the husband's earnings and accumulations during the marriage. She is as much entitled to be recompensed for that contribution as if it were represented by the increased value of stock in a family business.

Thus, in this 1969 case, the California Appellate Court decided that the goodwill of the husband's medical practice should be divided as part of the marital estate even though it could not be sold.

Any state that valued personal goodwill followed an investment value standard and a value to the holder premise. If it allowed only enterprise goodwill, it followed a value in exchange premise and a fair market value or fair value standard.

Shareholder Level Discounts

Shareholder level discounts: In what we have characterized as a value in exchange state, the standard of value is usually viewed as between Fair Market Value and Fair Value. These standards of value assume some sort of transaction or exchange of the interest. It is widely acknowledged by valuation practitioners that a minority interest in a closely held business is typically not worth its proportionate share of the whole value of the entity.

Accordingly, when starting from the proportionate share of the whole value of the entity, a discount to reflect the minority status of the interest is applied, when appropriate. There can be a difference between fair market value and fair value concerning the treatment of discounts for minority status and lack of marketability. Under the fair market value premise, the exchange is of the individual interest at the shareholder level and, therefore, in estate and gift matter, minority and marketability discounts are considered, and, when appropriate, applied. Under the fair value premise in certain matters, the business is presumed to be sold with the shareholder receiving his proportionate share of the business value often without regard to discounts at the shareholder level. Hence discounts for minority and marketability are often not applied. The argument often made in matrimonial matters is that there is no intention to sell the business or a spouses' share of the business and therefore discounts as discussed above are not applicable.

This would imply a fair value or investment value standard. It should be remembered that under the fair market value standard, no actual sale need be contemplated. Fair market value assumes a hypothetical transaction between a hypothetical willing buyer and a hypothetical willing seller. Therefore the argument that the business or interest should be valued assuming no actual sale implies a standard of value different from fair market value. This is usually fair value (no shareholder level discounts), which assumes the sale of the whole company, or investment value, which assumes no sale at all.

In what we have characterized as a value-in-exchange state, the standard of value is usually viewed as between Fair Market Value and Fair Value. Under the fair market value premise, the ownership interest valued is that of the individual
and, therefore, minority and marketability discounts, which are properly considered in estate and gift tax matters, are taken. Under a fair value standard or an investment value standard, discounts are not taken.

Fair Value is typically expressed as a percentage of the whole without discounts. The argument commonly put forth in matrimonial matters is that the spouse is not intending to sell the business and, therefore, discounts are not applicable. This would imply a fair value standard. Remember, under a fair market value standard no sale need be contemplated. The transaction is a hypothetical transaction between a hypothetical willing buyer and a hypothetical willing seller. There is a methodology used to determine what the individual interest would be worth in a free and open market. A fair market valuation is often performed where no sale is contemplated. The use of minority and marketability discounts implies a fair market value standard as opposed to a fair value standard. The disallowance of minority and marketability discounts implies a fair value standard.

Buy/Sell Agreements

Buy/sell agreements are helpful to determine standard of value employed in a particular state due to the context in which the agreements are used. For instance, in Colorado, a state we believe is an investment value state, the court rejected a valuation based on the partnership agreement because the husband intended to stay with the firm. In re: Huff, 834 P2d 244 (Colo.1992). Since the argument put forth was that the stockholder agreement was not relevant because there was no intention to sell, the proper valuation should be in accordance with investment value because this standard allowed the court to determine the value of the partnership interest in use (a value-to-the-holder premise). In contrast, in Connecticut, a fair market value state, the court rejected the buy/sell agreement in Dahill v. Dahill, 1998 Conn. Super. LEXIS 846 (Conn. Super. Ct. Mar. 30 1998), because the buy/sell agreement did not provide for the fair market value of the business.

Conclusion

Through our analysis, we concluded that there is a continuum that begins with states that value only marketable enterprise goodwill, and ends with states that value personal goodwill on the other end of the continuum.

William J. Morrison is the President of Morrison & Company in Paramus, NJ, and can be reached at w.morrison @morrisoncpa.com. Jay E. Fishman is the Managing Director of Financial Research Associates in Bala Cynwyd, PA. He can be reached at Jfishman@ finresearch.com.