The immediate motivation for this article arose out of the early afternoon session on Brown v. Brown at the annual Family Law Symposium on Jan. 28. During that session, there was a fair amount of animated discussion about how that appellate decision proscribed the use of discounts in the valuation of a business within the context of a divorce action (absent extraordinary circumstances), and how such relative prohibition translated into the establishment or, perhaps, the encouragement, of "value to the holder" (VH) as a standard of value.
If the title of this article was not obvious enough, consider the following. Give the proverbial one dozen valuation experts the exact same fact pattern for the valuation of a minority interest in a closely-held business. Ask them to provide their determinations of the fair value (FV), the fair market value (FMV), and the VH, of that minority interest. You can expect the procedures employed by these dozen experts to calculate FV and FMV to be similar and widely recognized. You can also expect their determinations of value will, in all likelihood, be within a fairly reasonable, narrow range. However, their determinations of value under the VH standard will not yield any similar uniformity not in the format, style, or sequence of valuation; not in the steps or processes taken; and certainly not in the determination of value. That is because VH is not a standard of value. There is no widely recognized definition of VH, nor is there peer testing or recognition of what it means or how an expert would go about valuing an interest in a business entity under a VH concept.
Brown v. Brown put significant limitations on the ability to use discounts in the valuation of a closely held business in the context of a divorce action in New Jersey. Because of that near proscription against discounts, there has been some discussion among family law practitioners and forensic accountants that the Brown appellate decision has created (or supported) the idea of VH. The problems with same include that nowhere in the Brown decision (with one very minor exception) is there any reference to VH, or anything that could be interpreted to mean such. The one slim exception is that in a single place in the decision, the court refers to the value of Mr. Brown's 47.5 percent interest in his hands; the impetus for such reference is the lack of any expectation or intention of selling that interest or the business entity in total and, thus, the court deemed it unfair to allow discounts against the value of that interest. Nowhere else in the decision is it possible for one to interpret or extrapolate the VH concept.
Frankly, the literature and discussions on this subject cause us to conclude that the current interest in accepting (creating?) a VH standard is the result of the misguided outgrowth of the frustrations of some family law practitioners with the FV and FMV standards and their use in determining equitable value in a divorce matter. To them, it would appear that something better has to exist and they have embraced this VH concept as that something better. However, there is no clear definition of VH; it means different things to different people and, as briefly illustrated in the opening part of this article, different experts will provide completely different results in any attempt to determine a value under a so-called VH standard.
What is meant by VH, and how might it yield an illogical result? Let us take a situation that we all (probably) run into a small business, 100 percent owned by one individual (or maybe owned equally by two people), that provides a living wage to the owner(s). When we look to see what this owner might earn were he/she to work in the outside world for somebody else (roughly speaking, the reasonable compensation concept), let us say we find that while this owner is making $100,000 working for him/herself, were that owner to be working for perhaps a larger competitor, he/she would be earning $120,000. However, to this owner, being his/her own boss means a lot arguably $20,000 a year. Under either the FV or FMV standard there would be a determination of no value to this business (other than the tangible assets; let's not consider those at this time). But, under a VH standard, an argument could be made that there is a value to being your own boss.
Thus, some expert could come up with a determination that this business is worth something let us assume for the moment, five times the payroll differential; which means five times $20,000 or $100,000. Thus, with the use of this overreaching application of so-called professional judgment, and taking the concept of VH in a literal, interpretive sense, to this owner, that business is worth $100,000, because it is worth it to that owner to make $20,000 a year less than the market would pay him/her for the privilege of being his/her own boss. Under the tortured absurdity of a VH, presto, you have a value. VH presents the opportunity for, and actually invites, extreme subjectivity giving the user the ability to derive a value of virtually whatever the expert (or that expert's client) wants to conclude.
Some practitioners suggest that VH should be calculated by valuing, in some fashion (which is perhaps the key to this quandary) the income (or perhaps cash flow) stream (after normalization adjustments) inuring to the person whose interest we are valuing (thus, VH). In some ways, this is no different than the standard income capitalization approach to value. Thus, by one line of thinking, we have already established VH as an income approach, one that already works very well under either FV or FMV. Why then the need to imagine that there is something different, or the need for something other than what is well established? But, assuming that there is merit to this concept, consider at least the following questions/issues related to VH:
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Are we using just one year or multiple years? Which years?
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Do we tax effect this income/cash flow number?
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Do we tax effect the perquisites/benefits that are received "tax-free"?
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How do we factor in years where there is an investment in fixed assets (cap ex) affecting the available distributions?
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Does it matter if we are talking about a minority interest or a controlling interest, and how small of a minority?
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How much do we take into account widely varying distributions/bonuses?
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Even if we could agree on all the above (and we have only touched on some of the problems), what do we then do with this magic number we have determined?
Indeed, VH is an ill-conceived, unworkable solution waiting to find the appropriate problem. And, that "problem" depends very much on which side you are on, which is going to vary from case to case. Further, as is illustrated in this article, VH can be more than or less than FV or FMV it very much depends on in whose hands VH is being determined, for which client, and for what purpose.
It further implies that there is something better than what we are using now. That word "better" is questionable; better to whom and when? It is rather easy to be frustrated with specific problems, but they do not necessarily extend to the universe of cases. In certain matters, those with perhaps more difficult or atypical fact patterns, creativity in the solution of the case is necessary. But that does not, should not, cause the creation of a fiction to satisfy a practitioner with an agenda. And, as has been expressed already in this article, one side's agenda is in conflict with the other side's agenda. A so-called VH, in skilled though misguided hands, can accommodate either one.
This suggests that the real problem, at least to some practitioners, is failing to provide for discounts (which most likely is of significance only as to a minority share owner). Thus, implied is the desire to go back to the good old days of FMV, which virtually always will yield a lower value than FV to any particular minority block of stock or interest. That then goes to the essence of why the appellate court in Brown v. Brown saw fit to reverse what was previously done in family courts FMV. We could argue back and forth as to whether in a, for instance, 25 percent owner situation, FV or FMV is "fairer." Of course, fair for one person may be unfair to another.
If there is an issue as to the utility or acceptance of a particular approach to value, then it is a matter of going case by case, relying on the facts of the case, as well as the liquidity of the parties, to try to craft the appropriate settlement. It is not a value issue, and playing with the concept of value is a cowardly way of dealing with the issue at hand.
As if family law practitioners would need any encouragement, considering the strident position taken here, we do invite responses, rebuttals, and all sorts of commentary. However, please no 3:00 AM tweets laden with alternative facts.
