A recent nasty divorce case centering on the husband’s dental practice offers up a number of interesting valuation questions, including whether the final valuation was subject to a marketability discount (DLOM) and whether there was enterprise goodwill.
The practice had two dentists—the husband and an associate dentist—as well as nine other full-time employees. In 2003, the husband received an offer for $913,000, but he declined to sell the practice, and in 2006 he signed a net worth statement that claimed the practice had a value of $1 million.
Serious noncompete adjustment: The wife’s expert used three methods—the summation of assets method, the gross revenue multiplier method, and the capitalization of earnings method—and averaged the resulting values to arrive at a recommended value. He then deducted the amount of goodwill belonging to the husband and concluded the practice was worth $678,179, not counting the entity’s debts, cash, or accounts receivable. The husband’s expert ultimately relied on an income-based approach and concluded the corporation was worth $50,000. At the same time, he explained it actually had a “deficit net worth” because debt exceeded assets. There was practically no enterprise goodwill because neither dentist had a noncompete agreement, he concluded. Moreover, based on various studies and factors specific to the practice at issue, he believed a 15% DLOM was appropriate.
The trial court said the husband’s expert supported his computation with “greater industry data” and more appropriate benchmarks and his valuation “takes into fuller consideration the debts of the practice and the value of the accounts receivable of the practice.” The wife’s expert risked overstating the goodwill of the practice “given the tenuous nature of the practice and the lack of an agreement not to compete with the other dentist in the practice.” The court gave little weight to the past offer. Interestingly, its starting point was $677,796, only $383 less than the value the wife’s expert proposed. But the court reduced the amount substantially to account for the noncompete attributable to the associate dentist: 12/21 of the total value. And, it also applied a 15% DLOM “via the Husband’s expert opinion.” By its calculation, the practice was worth $328,392.
The appeals court largely agreed with the trial court but said that under the applicable case law a DLOM was improper where there was no need or desire on the interest holder’s part to sell his interest. Since the husband expressed no intention of selling his interest in the practice, the lack of marketability did not affect its value. Consequently, it ordered that the 15% DLOM ($57,951) be added back into the value, bringing the total value to $386,343.
Splitting the baby? Jim Alerding (Alerding Consulting) points out that the value the trial court came up with actually was very close to 50% of the value the wife’s expert had determined. In fact, the court mentioned that it would try to “get as close to a 50/50 division as practically possible.” This, Alerding says, seems to be its way of doing it, and it’s not uncommon in divorce cases where courts tend to “split the baby.” He also finds the appeals court’s decision to eliminate the DLOM “interesting” because the court did not object to the DLOM percentage but only to the trial court’s failure to adhere to a “no-sale assumption.” Some states, such as Virginia, do not assume a sale but also state that the “value to the holder,” not the fair market value (FMV) standard, is controlling, Alerding explains. The trial court’s reduction in value for the noncompete attributable to the associate doctor is appropriate in a FMV setting because the buyer cannot obtain that value by purchasing the practice, Alerding adds.
Find a detailed discussion of Barnes v. Barnes, 2014 Tenn. App. LEXIS 200 (April 10, 2014), in the July edition of Business Valuation Update; the court’s opinion will appear soon at BVLaw.