Discounts are ‘necessary,’ not just ‘appropriate,’ says appellate court

BVWireIssue #131-2
August 14, 2013

Cash equivalent or in-kind distribution—does it matter in what form a spouse receives her (minority) ownership interest in a closely held family business? The Rhode Island Supreme Court recently answered this question when it reviewed “a protracted, if not epic, battle” for divorce.

Distribution without valuation. In dispute were two family-owned businesses that “comprised an enormous portion of the marital estate,” somewhere between $106 million and $126 million. Three experts—one for each side and one whom the trial court appointed—found they were unable to provide definitive valuations. Therefore, the trial court decided not to assign a value to the assets but instead ordered an in-kind distribution of the ownership interests, with 25% going to the wife and 75% to the husband. The wife appealed, objecting primarily that the distribution rendered her a minority shareholder in the closely held businesses.

The appellate court agreed, ruling that the trial court should have determined a value for the businesses and for the portions that were distributed to each party considering the amounts at stake. Also, the law generally disfavors assigning stock in a closely held corporation in a way that makes one spouse a minority shareholder. Even if this type of distribution is not error per se, it was in this case because the parties received unequal percentages. “[A] 25 percent minority share of a closely held corporation will likely not be the equivalent of 25 percent of the total value of the company,” said the court, because that type of stock lacked liquidity considering “there is no established public market for the stock.” Moreover, “a minority shareholder lacks control over the company, and, therefore, the value of his or her stock is diluted in comparison to that of a majority shareholder.”

Given these limitations, the court said, “both a minority discount and a marketability or illiquidity discount must be applied when valuing the portions of the companies that will be assigned to each party.” These discounts are not just “appropriate,” but “even necessary when valuing an in-kind distribution of a minority share of a closely held corporation in a divorce action,” the high court continued. They would not be necessary if the trial court had awarded the wife a cash equivalent of her equitable ownership interest in the companies.

Find the complete digest of McCulloch v. McCulloch, 2013 R.I. LEXIS 113 (June 25, 2013), in the September issue of Business Valuation Update; the court’s opinion will be available soon at BVLaw.

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