Arizona court rejects ‘realizable benefit’ approach to valuing professional practice goodwill

Calling it “the most intangible of intangibles,” the Arizona Court of Appeals acknowledged the “difficult task” of valuing professional practice goodwill (even in a state that's in the minority, accepting all goodwill as marital property without having to distinguish its personal/enterprise components). But did its new decision last week—which surveyed several states in considering whether to adopt the majority standard—help simplify the task?

At trial, the expert for the husband—who directed the litigation department of a national law firm in its Phoenix office—limited his interest to the $140,000 return of capital per the firm’s stock redemption agreement. By contrast, the wife’s expert—who used a capitalization of earnings approach—said it was worth closer to $1.3 million, including goodwill. Applying a “realizable benefits” standard, the trial court found the buy-sell restricted the value, “goodwill or otherwise,” to $140,000 and rejected anything else as “mere speculation.”

On review, the appellate court ruled this was wrong. Goodwill value doesn’t have to be “realizable,” it said, i.e., something “that can be bought and sold on the open market.” At the same time, goodwill cannot include a professional’s future earning capacity, per se, but only its “enhancement” through reputation, client patronage, and the firm’s “platform.” Notably, expert testimony can “help guide the court” in separating earning capacity from intangible values, but the appellate court declined to clarify (or complicate?) the expert’s task by adopting the majority rule and remanded the case for a reconsideration of value under its broad “equitable” standard.

What do you think? We’ll have the complete digest of Walsh v. Walsh, 1 CA-CV 11-0269 (Oct. 2, 2012) in the December Business Valuation Update. In the meantime, we’ve just posted the court’s opinion at our free downloads page. What does the decision add to the body of law on goodwill values in divorce? Please email your thoughts to the editor. (Note: Our thanks to Lynton Kotzin, of Kotzin Valuation Partners, who was teaching the ASA’s BV201 course in Phoenix last week and alerted us to Walsh.)