What quantity and quality of evidence does a trial court need to make a meaningful valuation of a business? This was the central question in a hard-fought divorce proceeding that featured questionable financial records, problematic expert testimony, and highly polarized value determinations.
‘Scant’ information: The husband owned a business whose exact nature was a mystery. He seemed to be a broker for the semiconductor industry and regularly dissolved companies and reincorporated them under a slightly different name. He was the 100% owner of the current incarnation. At trial, the husband testified that he did business “everywhere” and that the company had no inventory at that moment. Tax returns related to the predecessor company and the current business showed a massive decrease in income from 2010 to 2012. He said that the company’s recent poor performance was the result of “the bad economy” and “the semiconductor business was not doing well at all.” Also, “I was not in a situation to run the business,” he added. He concluded the company was worth zero. The wife hired an expert who reviewed the company’s website, certain corporate documents, tax returns, financial statements, and deposition statements the husband and his CPA gave. The wife’s expert said he received “scant” information from the husband. For example, he only had access to the company’s 2010 financial statement, which, he said, showed more than double the income the tax return listed. He expressed “some doubts about the correctness of the tax returns as filed,” concluding they were “prepared in a very taxable motivated fashion.” He noted that the business website stated the company had “the world’s largest inventory of semiconductor and manufacturing equipment parts.”
The expert relied on the market approach, reviewing 31 comparable companies, and came up with a value estimate of $2 million. He concluded there was goodwill value attributable to the husband and applied a discount of 30%, resulting in a $1.4 million intrinsic value. He acknowledged that, in light of the limited data available to him, his valuation did not meet AICPA standards. But, he said, his calculation was based on “sound foundation and fact and accounting theory.” He maintained his work product for trial was “useful and … a reasonable estimate of the value of the company as it [was].”
Mixed message: The trial court concluded it did not have sufficient evidence for a valuation. It cited the husband’s statement that the company was worth zero dollars and found that “almost all of what [the expert] relied upon to form his opinion was not in fact correct.” On review, the appeals court acknowledged the obstacles. “At best, husband’s testimony regarding [the company] was vague, indefinite, and confusing,” it said. The husband provided “scant and indefinable” information to the wife’s expert. Also, the expert’s valuation came with caveats. Then the appeals court changed its tune. Citing case law on what amounts to “sufficient and credible evidence,” it said the trial court “had a relative wealth of information” with which to value the business. Both the husband and the wife’s expert stated figures. The wife’s expert used an accepted method, and, even though he did not produce an AICPA standard value, he called his determination “a reasonable estimate” of the company’s value as it was. Therefore, the appeals court ordered the trial court to perform a valuation and make an equitable distribution.
An extended discussion of Hugh v. Hugh, 2014 Va. App. LEXIS 222 (June 3, 2014), appears in the September issue of Business Valuation Update; the court’s opinion will be available soon at BVLaw.