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Defining value in divorce


Be advised that I, Eric Roy, wrote this article for my and my staff's benefit. I am a lawyer of course but I am not a CPA. Thus if you wish for a more comprehensive understanding of the subject matter I suggest you purchase a book on forensic accounting or business valuation. There are books written on the subject by CPA's such as Shannon Pratt and Aliina Niculita who are considered leading authorities on this subject matter.

Many practitioners take this word "valuation" for granted. This can be a mistake as the interpretation of this word and the resulting employment of that interpretation can have dramatic effect on an entities ultimate valuation. Thus from the beginning of any case, before any valuation occurs, you should be thinking of what definition of value should be employed in your case. If you can get an order from the court early on as to this value definition you can avoid potentially costly future litigation. Thus get together with counsel to iron out a term of valuation and put it on the record early on in the case. If opposing counsel isn't sophisticated in this realm then simply seek an order recognizing your preferred definition early on so as to gain advantage in final settlement or trial. Once you have your valuation definition ironed out you can advise any business evaluators and/or appraisers as to what definition they will be operating under in forming their opinions.

First and foremost you need to be familiar with the term "fair market value" which is the most commonly used standard of valuation, at least here in the United States. Fair market value is treated with deference given its application in state and federal tax matters. Fair market value is defined by treasury regulations as being the net amount in which a willing buyer would pay to a willing seller assuming both parties have knowledge of the relevant facts and neither party is under any compulsion to buy or sell. This is thus a hypothetical transaction taking into account not specific buyers or sellers but the entirety of the market of buyers and sellers. This means that you can't argue that the price would be higher or lower given special circumstances or factors which are exclusive to a specific buyer or seller. This definition also assumes that such transaction will be a cash transaction. Thus adjustments will not be made for assumptions of financing and the like. Both parties are assumed to have the capacity to buy or sell the property. Thus you can't argue that a buyer does not have the capital to acquire the entity at issue. It is assumed that sufficient funds are in place. Also keep in mind that under this fair market value definition the value is determined as of the valuation date, not any other future date and without any speculation as to unforeseeable future events. The fair market value approach assumes the highest and best use to which a property could be used on the given valuation date. It thus considers uses that are available to that specific entity assuming that such uses are realistic. Thus it is inconsequential whether the existing owner is or has used his business or asset in its most profitable use in the past or presently. We only consider what the value would be if the asset or entity was employed in the most profitable fashion. It is impermissible to account for circumstances which might affect the value of the entity if those circumstances are possible but not reasonably probable.

There are times when the equity being appraised does not constitute the entirety of the asset. For instance this will be the case when you are dealing with a partnership interest or other minority interest in an asset or organization. When this is the case the fair market value of the equity interest can be discounted. The discount will often be proportionate to the liquidity of the equity share.

Another value expression, easily confused with fair market value, is "fair value". Unfortunately, fair value is an ambiguous terms defined differently depending on the controlling authority or evaluating organization. This valuation term typically applies in situations where dissenting members of an organization feel that the business entity at issue is being sold for less than adequate value. In this circumstance the purpose of the valuation is to determine the value of the equity interest immediately before the effectuation of the sale or transaction in which the shareholder objects. Under this approach there is no discount applied for a lack of liquidity or lack of marketability of the equity interest. Thus the fundamental difference between fair market value and fair value is that in the prior we assume that a willing buyer and a willing seller exist while in the later we do not necessarily assume that a willing buyer and a willing seller are in existence.

Be advised that there is another definition for fair value promulgated by the Financial Accounting Standard Board (FASB). The significant differences here is that the value of an asset or equity interest is defined by an exit price rather than the price which would be paid to acquire the asset. There are other nuances involved in this definition that I will not go into here. Just be aware that fair value is defined in numerous ways and thus ambiguous at best.

Investment value is value to a specific investor. This is in opposite to fair market value which assumes a pool of hypothetical buyers and hypothetical sellers. Investment value looks directly to the value of one particular buyer or investor. Thus, investment value is subjective whereas fair market value involves an objective methodology. Thus investment valuation takes into considerations various factors such as synergies which may be obtained by way of merger or acquisition, estimates of earning power and or risk by the acquiring entity, and others.

Intrinsic value, or fundamental value, is value as perceived by analysts. Thus we don't look at a particular investor's considerations as we would using the investment valuation method. This is typically the method of securities valuation. Analysts look at factors such as expected earnings, cash flow, capital structure, quality of management, amongst others in making this valuation. Thus the free market and the analyst may be at odds as to the value of a security. If the analyst deems the interest as being more than what the market deems to be the value then the analyst deems the interest as a "buy". The opposite result occurs where the analyst values the interest as less than what it is actively trading for. In which case it is deemed a "sell".

Accountants often use the term "book value" in determining value. This method of valuation looks to valuation of assets by looking at historical costs and then subtracts out depreciation and amortization. In the case of business valuation, after reducing assets by that asset's proper depreciation and amortization the accountant will then subtract total liabilities. This will result in an entities book value. Of course this method has its flaws in that it only takes into consideration those assets and debts which appear on the balance sheet. Often times a company's most valuable asset of all is its goodwill value which is intangible and thus not apparent on the balance sheet. Thus this "book value" falls short at times.

In contrast to this book valuation method above, the "going concern" valuation method considers the entirety of the entity for purposes of valuation. Thus this includes tangibles and intangibles. This is the total value of operating assets, systems, personal, and other assets of the organization which all work together to propel the organization forward. Liquidation value looks to the net value that can be realized by an orderly forced sale of all business assets. Synergistic valuation looks to the value that can be realized by way of synergies gained through merger of businesses. In this sense this method looks to the particular circumstances of individual buyers and sellers. This method looks to economies that can be gained, increased market share value gained, and other gains realized by way of the acquisition.

Lastly, understand that the term "transaction value" looks to actual past sales as opposed to value assessed by way of a potential future sale. Thus this method will not be used for valuing asset for future reference but is used when looking at a transaction which has already occurred.

What we see from these various definitions of value is that they all contain some commonality and differences with other valuation methods. It is important to have a general understanding of the valuation method employed by an evaluation expert. You need to be able to cross examine and direct examine intelligently. To do this you need to understand the core concept of valuations and those used in your particular case's circumstances. To confuse the matter further understand that determining what value definition to use can be a struggle. The struggle is a result of the lack of consistent definition found throughout statutes and case law. Typically, financial matters and definitions are misunderstood and/or not thoroughly defined in the case law or otherwise not found at all in the statutes. Thus the practitioner has a variety of resources to look to in obtaining fodder for argument for a particular valuation method. As stated in the beginning, get your valuation method figured out up front. Get it on the record so you aren't arguing for a specific method post valuation. Once you have your valuation method ironed out you can direct your expert as to what approach he or she will be using.

Categories: Family Law