Minority Discount Business Appraisal AZ Divorce | Hildebrand Law, PC

Wed 17th Jan, 2018 Arizona Community Property Laws

Many times during a dissolution of marriage, the need arises to evaluate a business so the court can determine the community interest in making an equitable distribution of the community assets and debts. Problems can arise in determining the value of the business.

This can be further complicated if one or both of the spouses take a salary from the business. Such was the case in the case of Schickner v. Schickner. The Arizona Court of Appeals delivered an opinion on the subject of valuing business interests and how they should be dispersed between the parties in a dissolution of marriage.

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A Brief History of the Case: Schickner v. Schickner

Mr. and Mrs. Schickner married in 1998. During their marriage, they acquired a 50% community interest a business where husband operated his professional practice as an ophthalmologist (“WME”) and a 20% interest in a business where husband performed surgeries (“PSC”). At trial, the primary contested issues were the calculations surrounding the two businesses to determine the amounts Husband owed to Wife for acquiring her community property interest in the two companies.

Each party obtained expert opinions regarding the valuation of the business including valuing the business using the minority share and marketability discounts. For the community’s 50% interest in WME Husband’s experts testified that the value could range from $475,000 (applying minority share and marketability discounts), which is referred to as the Fair Market Value approach, to $830,000 (not using minority share and marketability discounts), which is referred to as the Fair Value Approach. As to PSC Husband’s experts testified the 20% interest to be valued between $490,000 and $580,000.

Wife’s expert presented a valuation of $1,617,000 for the WME and a business valuation of $1,052,000 for PSC. Wife contended that Husband’s experts incorrectly assessed the marketable value of his interests by evaluating them as if they were being sold to a third party.

She asserted that discounts for lack of marketability and lack of control were only considerations if an outside buyer is buying into a practice, and irrelevant when calculating the value of a present owner “buying out” the interest of another current owner.

Husband disputed Wife’s valuation, arguing, among other things, that it applied a capitalization rate that was too high and didn’t include a discount for lack of marketability and lack of control for both businesses.

The trial court ruled that the fair market value of the community’s interest in PSC was $536,000 and their interest in WME was $602,000, ordering Husband to pay Wife $569,000 for her half of the community interest in the two businesses.

Wife appealed the decision to the Arizona Court of Appeals, contending the trial court undervalued the community’s interest in the two businesses; specifically asserting the trial court applied a minority share discount in contravention of Arizona law.

The Court of Appeals found the trial court did not correctly value WME

Minority Discount Business Appraisal Arizona Divorce.

According to state statute, the trial court must divide community property equitably, though not necessarily in kind, and as a general principle, all joint marital property should be divided substantially equally unless a sound reason exists to divide the property otherwise.

A trial court has the discretion to consider whether a minority discount is appropriate, on a case by case basis, considering factors such as the minority shareholder’s degree of control, lack of marketability, and the likelihood of a sale of the minority interest in the foreseeable future.

Because a minority share discount is an attempt to take into account the difficulty of actually turning an asset into money, the appellate court believed its application may be inappropriate when the evidence doesn’t support underlying assumptions regarding lack of control and lack of marketability.

When the appeals court applied these principles to WME, the trial court’s valuation was not supported by the evidence. Husband owned a 50% membership interest in WME, equal to that of the only other member of the limited liability company.

The record reflected that Husband held significant power regarding financial decisions. Although Husband testified he was not able to modify the terms of WME’s rent, which were fixed by contract, the record does not otherwise reflect any substantial limitations on his joint control of that company as a 50% member.

Minority Discounts and Valuation of Company in Arizona Divorce.

Further, Husband presented no evidence he had any plans to sell his interest in the business. Thus, for WME, the appellate court ruled that the record did not support the underlying assumptions justifying the application of a minority share discount and the trial court abused its discretion by valuing WME at $602,000.00.

This figure was substantially below not only Wife’s valuation of $1,617,000.00, but also Husband’s $830,000.00 when not applying a minority share discount, and even below his $620,000.00 valuation which did apply the discount. Accordingly, the appellate court vacated the ruling as to WME and remanded for a revaluation and equitable distribution of the community’s interest in the first business.

In respect to PSC, Husband again did not testify regarding any intent to sell his interest in the business. However, he only owned a 20% share in PSC and Wife had not cited, nor had the court’s review of the record revealed, any basis for concluding that Husband’s control over PSC was not substantially limited by the holder of the 80% interest.

Therefore, because the record supports the trial court’s application of a minority share discount and corresponding valuation of the second at $536,000.00, the appellate court discerned no abuse of discretion.

The differences in the valuation underscore the need to appropriately assess and evaluate the community interest in a business in a dissolution of marriage. Applying an incorrect method can lead to a valuation that may be over or under-inflated.

FAQ: Minority Discounts in a Business Appraisal in an Arizona Divorce

What is a minority discount in a business appraisal during an Arizona divorce?

A minority discount is a reduction in the value of a minority ownership interest in a business because that ownership lacks control over business decisions. In an Arizona divorce, courts may consider applying a minority discount when valuing a spouse’s ownership interest if the facts show the owner has limited control and the discount is appropriate under the circumstances.

Does Arizona automatically apply a minority discount when valuing a business in divorce?

No. Arizona courts do not automatically apply a minority discount. Instead, judges have discretion to determine whether a minority discount is appropriate based on the specific facts of the case, including ownership rights, control over the business, marketability, and other valuation evidence presented by qualified experts.

Why does a minority ownership interest have a lower value?

A minority ownership interest may be worth less because the owner generally cannot control major business decisions, force distributions, or direct the sale of the company. These limitations can reduce what a willing buyer would pay for that interest, which is why valuation experts sometimes apply a minority discount.

Can a minority discount significantly reduce the value of a business in divorce?

Yes. When applied, a minority discount can substantially decrease the appraised value of a spouse’s ownership interest. Because this directly affects property division, whether the discount should apply may be a contested issue in Arizona divorce cases involving closely held businesses.

What factors does an Arizona court consider before applying a minority discount?

Arizona courts may evaluate several factors, including:

The spouse’s percentage of ownership.
Whether the owner has voting or management control.
The marketability of the ownership interest.
Whether a future sale of the interest is likely.
The expert testimony presented during the business valuation.
The court weighs these facts on a case-by-case basis rather than following a fixed rule.

Can a minority discount be inappropriate in an Arizona divorce?

Yes. A minority discount may be inappropriate if the facts do not support assumptions about limited control or lack of marketability. Courts examine whether the evidence justifies the discount rather than applying it automatically simply because the ownership interest is less than 50 percent.

How is a business valued during an Arizona divorce?

Business valuation typically involves a qualified valuation expert who reviews the company’s financial records, assets, liabilities, earnings, ownership structure, and applicable valuation methods. Depending on the circumstances, the expert may also evaluate whether discounts for minority ownership or lack of marketability should be applied.

What is the difference between a minority discount and a lack of marketability discount?

A minority discount reflects the reduced value of a non-controlling ownership interest, while a lack of marketability discount reflects the difficulty of selling ownership in a privately held business. Although both can reduce a business valuation, they address different valuation issues and may or may not apply in a divorce case.

Who decides whether a minority discount applies in an Arizona divorce?

The family court judge ultimately decides whether a minority discount should apply after reviewing the evidence, expert testimony, and applicable Arizona law. The court has broad discretion to determine the most equitable valuation based on the facts presented.

Can expert witnesses disagree about minority discounts?

Yes. Business valuation experts frequently disagree about whether a minority discount should apply and how much the discount should be. The court evaluates each expert’s methodology, assumptions, and supporting evidence before deciding which valuation is more persuasive.

Arizona Divorce Attorneys for Business Owners

If you have questions about minority discount business appraisal in an Arizona divorce case, you should seriously consider contacting the attorneys at Hildebrand Law, PC. Our Arizona community property and family law attorneys have decades of combined experience successfully representing clients in community property and family law cases.

Our family law firm has earned numerous awards such as US News and World Reports Best Arizona Family Law Firm, US News and World Report Best Divorce Attorneys, “Best of the Valley” by Arizona Foothills readers, and “Best Arizona Divorce Law Firms” by North Scottsdale Magazine.

Call us today at (480)305-8300 or reach out to us through our appointment scheduling form to schedule your personalized consultation and turn your Arizona community property or family law case around today.

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