EQUITABLE DISTRIBUTION - VALUATION

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EQUITABLE DISTRIBUTION - VALUATION

• LAW VALUATION
• WAKE FOREST UNIVERSITY LAW SCHOOL
• April 14, 2004
• A. Doyle Early, Jr.

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Standard of Value for Equitable Distributionin
North Carolina?

• A. Fair Market Value - Poore v. Poore (1985)
• B. Investment Value
• C. Intrinsic Value - Fountain v. Fountain (2002)
• D. Fair Value - Hamby v. Hamby (2001)
• Royals v. Piedmont Electric
• E. Going Concerns Value
• F. Liquidation Value
• G. Book Value/Adjusted Book Value
• H. Net Value - Beightol v. Beightol (1988)

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Fair Market Value

• Rev. Ruling 59-60
• The price at which property would change hands
  between a willing buyer and a willing seller,
  when the former is not under any compulsions to
  buy and the latter is not under any compulsions
  to sell, both parties having reasonable knowledge
  of relevant facts.
• Carlson v. Carlson
  (1997)

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Valuing Stock Options

• 1. Intrinsic Value - Fountain v. Fountain (2002)
• 2. Black Scholes Method

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Valuing Closely Held Corporations and
Professional Practices

• Further, in reviewing the trial courts
  valuation of an ongoing business or an interest
  therein for purposes of equitable distribution,
  the task of the appellate court is to determine
  whether the approach used by the trial court
  reasonably approximates the net value of the
  business interest. If it does, the valuation
  will not be disturbed.
• If no credible evidence is presented as to value
  of business, the court does not have to value it.
  Grasty v. Grasty (1997)

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Factors to be Considered under Revenue Ruling
59-60

• 1. The nature of the business and the history of
  the enterprise from its inception.
• 2. The economic outlook in general and the
  condition and outlook of the specific industry in
  particular.
• 3. The book value of the stock and the financial
  condition of the business.
• 4. The earning capacity of the company.
• 5. The dividend paying capacity.
• 6. Whether or not the enterprise has goodwill or
  other intangible value.
• 7. Sales of the stock and the size of the block
  of the stock to be valued.
• 8. The market price of stocks of corporations
  engaged in the same or similar line of business
  having their stocks actively traded in the free
  and open market, either on an exchange or over
  the counter.

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Approaches to Valuation

• 1. Income Approach
• A. Capitalization of Earnings
• B. Capitalization of Discounted Cash Flow
• C. Capitalization of Discounted Net Income
• 2. Asset Based Approach
• A. Adjusted Book Value
• B. Liquidation Value
• C. Capitalization of Excess Earnings
  (Rev. Ruling 68-609)
• 3. Market Comparable Approach
• A. Sales of Comparable Companies
• B. Arms-Length Transactions
• C. Prior Sales of Company Stock
• D. Consideration of Restrictive Agreement
  (Buy-Sell) - Fox v. Fox (1991)
• E. Use of Industry Standard Approaches (Rules of
  Thumb) - Smith v. Smith (1993)
• 4. Trial Court is permitted to average the
  approaches utilized by the experts - Sharp v.
  Sharp (1994)
• 5. To Challenge methodology, the party must
  object to the admissibility of the evidence -
  Walter v. Walter (2002)

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Capitalization of Excess Earnings (Revenue
Ruling 68-609)

• 1. Average Earnings Normalized 50,000.00
• 2. Average Tangible Assets 200,000.00
• 3. Fair Percentage Return (10) 20,000.00
• 4. Average Earnings Attributable to
• Goodwill or Excess Earnings (1. - 3.)
  30,000.00
• 5. Capitalized Averaged Earnings
• Attributable to Goodwill at 20
• (Multiply by 5 to get the value of
• Goodwill) 150,000.00
• 6. Add 2. And 5. For Total Business Value
  350,000.00

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Capitalization Rates

• 1. The rate used to convert income into an asset.
• 2. Determine the discount rate, which represents
  the total annually compounded rate of return the
  investor requires over the life of the
  investment.
• 3. Capitalization rate is discount rate minus
  long term growth. C D - g
• 4. A capitalization rate reflects risk.
• 5. A capitalization rate may be expressed in a
  percentage or a multiple (I.e., a 25
  capitalization rate results in a multiple of 4).
• 6. Capitalization rate equates to P.E. (Price
  Earnings Ratio)
• 7. Court can choose its own capitalization rate
  - Smith v. Smith (1994)

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Build-Up Method

• 1. Risk-free, long-term (20 yr.) government
  bond rate 7.30
• 2. Equity (common stock) risk premium
  7.40
• 3. Small company risk premium
  5.10
• 4. Specific company risk premium
  8.00
• (Determined by appraiser)
• 5. Discount rate
  27.80
• Less long-term growth of - 5.00
• Equals Capitalization rate of 22.80

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Example of Weighted Value

• Year Net Income Weight Weighted Net Income
• 1985 95,000 1 95,000
• 1986 102,000 2 204,000
• 1987 115,000 3 345,000
• 1988 140,000 4 560,000
• 1989 154,000 5 770,000
• Total 606,000 15 1,974,000
• 1,974,000 15 131,600

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Discounts or Premiums

• A. Minority Interest Discount v. Control Premium
• B. Lack of Marketability Discount (Liquidity)
• C. Discount for Loss of Key Man
• D. Discount for Trapped-In Capital Gains - Davis
  v. Commissioner (Discount allowed for trapped-in
  capital gains although there was no sale or
  contemplated sale of the asset on the date of
  separation.)
• E. ButDolan v. Dolan (2002) - the value of
  commercial real estate should not be adjusted
  for capital gains distribution did not
  contemplate an immediate sale
• F. Clark v. Clark (1980) - Alimony
• G. Shannon Pratt

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The Trial Judge as Gatekeeper for Expert Testimony

• 1. Daubert v. Merrell Dow Pharmaceuticals, Inc.
  (1993)
• Scientific testimony
• 2. Kumho Tire Co. v. Patrick Carmichael (1999)
• Expanded to technical or other specialized
  testimony
• 3. Howerton v. Arai (2003)
• Danbert applied in N.C.
• 4. Walter v. Walter (2002)
• Applies to valuation methodology if there is
  objections
• 5. Rule 702 - If scientific, technical or other
  specialized knowledge will assist the trier of
  fact a witness qualified as an expert may
  testify hereto in the form of an opinion.

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The Trial Judge as Gatekeeper for Expert Testimony

• 6. Questions for the trial judge
• A. Whether testimony is based on scientifically
  valid reasoning or methodology
• B. Whether the reasoning or methodology can
  properly be applied to the facts at issue
• 7. Factors to consider in determining
  admissibility
• A. Whether theory or technique can be and has
  been tested
• B. Whether it has been subjected to peer review
  and publication
• C. The known or potential rate of error
• D. Whether the theory or technique has achieved
  general acceptance in the relevant field