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Levels of Value and Premises of Value in Divorce


I, Eric Roy, wrote this article to reaffirm my understanding of these value concepts within the context of business valuation in divorce. These concepts should be well known to your business valuation expert as such experts employ these concepts regularly in their work. For a thorough understanding of this subject you should consult with a business valuation expert who can really give better insight on the subject. What I have written here is primarily for my own as well as my staff's benefit.

The first concept we need to understand is this "level of value" concept. Level of value is calculated by looking at two different considerations. The first of those is the degree of control over a business interest. For instance assuming that two different individuals have ownership in a business. Say one owner has a 30% equity interest and the other owner has a 70% equity interest. Upon first impression we might think that if the business is worth $1,000,000 that the 30% ownership interest should be valued at $300,000 while the 70% ownership interest should be valued at $700,000. However, when we take into consideration this value for control we take our analysis a step further than simply applying a proportionate dollar figure to the percentage of equity interest. When we look at level of control we realize that the 30% ownership interest is in fact worth less than 30%. The reason for this is that the 30% ownership is a minority interest. Since this owner has a minority interest he has less control in the movement and direction of the company. To the contrary, the 70% majority interest has more control. The majority interest has power beyond that of the minority interest owner. Thus for purposes of valuation we can discount the value of an equity interest proportionate to the lack of control realized by that interest.

After we take consideration for lack of control we move on to the next factor in our level of value analysis. This factor looks at any lack of marketability which may be present within this asset or business interest. Lack of marketability refers to any difficulty present in marketing or selling off equity interest. You will primarily consider this discount when looking at closely held corporations and its closely held shares or when valuing restricted stock. Closely held corporations are corporations in which the equity of the company is held by a few shareholders who own the entirety of the business interest. This is in contrast to publicly traded corporations which have their stocks traded on public exchanges. It is obviously much easier to buy and sell stock on an exchange than it is to buy and sell closely held interests. Thus a discount is applied to closely held equity interests. Another occasion where a discount will be applied is within the context of restricted stock. Restricted stock is stock, typically granted to employees, which becomes transferable (vests) after certain conditions have been met. These conditions typically include duration of employment. Thus prior to this vesting period the stock is not transferable. Given this lack of transferability or marketability a discount need be applied so as to reduce the value of that equity interest.

Thus when we apply levels of value we look to both control and liquidity. Remember that we apply both of these factors and we apply them one after the other. Thus first you would look to apply a discount for any lack of control. After discounting for lack of control you can go on to discount for lack of liquidity or marketability. You as counsel should consult with a valuation expert prior to initiation of valuation procedures. Consult with your expert to determine what level of value your expert should apply prior to initiation of the appraisal.

After we have considered what level of value to apply to an entity we go a step further and look at premise of value. Premise of value looks to any assumptions that should be made as to the status of a business at time of evaluation. For instance, should the business be seen as an ongoing organization or as a collection of assets ready to be disposed of? You should be speaking to your valuation expert early on to see what premise of value they intend to apply. If left to their own discretion they may apply the premise of value that reflects the most lucrative use of the business. This may or may not be in your favor depending on what side of the case you are on. The premises of value selected may be a result of whether a minority or majority interest is being valued. If you are dealing with a majority interest then your expert would likely value the entity as a going concern but your expert would likely appraise assets not necessary to operations on a liquidation basis, discussed in the following paragraph. If your expert is valuing a minority interest then perhaps he or she will apply the going concern value as the appraiser wouldn't assume that assets might be sold in this situation unless there is actual evidenced that the business in fact may be sold shortly.

Generally, there are four different premises of value to choose amongst. Value as a going concern assumes that the business is in use and will be valued as though it is in continued use and thus worth more than simply the sum of its parts. The second premises of value is value as an assemblage of assets. This premises assumes all the assets of the business as a whole but does not assume that these assets are in use for the production of income. The third premises is that of valuation as an orderly disposition. This valuation premises is similar to that of the assemblage of assets in that the assets are not in use but the difference is that the assets are presumed to be sold individually on the open market. The assumption under the orderly disposition method is that the assets enjoy normal exposure on the free market. Thus there is no rush to liquidate and the entirety of the market is available to bid. This is contrary to the assemblage approach which assumes a greater value as the assets are worth more when valued in bulk. Finally, the last premises of value is that of value as a forced liquidation. This premises is like the orderly disposition method except for the fact that the valuation assumes a forced liquidation of the assets on a piecemeal basis. Since a forced liquidation is assumed the value of the assets decline as the assets receive less than normal market exposure.

Remember from our article on value that there are many definitions of value. Note that any of the premises of value just described above can be applied under whatever definition of value you and your expert apply in your case. Thus you first can determine the definition of value to apply and then go on to consider levels of value and premises of value. For a much more thorough explanation of this material I direct you to read Shannon Pratt and Alina Niculita's literature on the subject. They are foremost experts in the field of business valuation and the source of most of my knowledge on the subject.

Categories: Family Law