Minority Discount When Valuing a Company in an Arizona Divorce
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 debs. 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.
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
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.
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.
If you are facing a divorce involving a business and need an Arizona divorce attorney who understands business valuation, call the Phoenix and Scottsdale Arizona divorce attorneys at Hildebrand Law, PC at (480)305-8300 to protect your community property interest in the business.