How is a Professional Practice Valued in an Arizona Divorce
A divorce can be complicated. A divorce in Arizona can become substantially more complicated when one of the spouses has a professional practice. Attorneys, doctors, dentists, mental health professionals and the like may all have a professional practice that has a value. Some or all of that value may be considered community property in a divorce.
All of these different professional practice areas have unique and distinctly different characteristics that do not lend well to a single cookie cutter way of valuing this business in a divorce. So, how is a professional practice valued in an Arizona divorce? The Arizona Court of Appeals in a published opinion in the case of Glover v. Glover addressed these issues.
In the Glover case, both spouses were attorneys. At the time of the divorce, the wife had a marketing and public relations company while the husband was a partner at a large law firm where he earned a substantial income. The issue in the divorce became the value of the husband’s business interest in the large law firm of which he was a partner. The issue came down to determining the value of husband’s “goodwill” for the purpose of dividing the parties community property interest in that “goodwill”.
Realizable Benefit or Capitalization of Earnings Approach to Valuing Goodwill
The law firm previously entered into a stockholder redemption agreement with the husband indicating that, upon his departure from the law firm, the firm would buy back his shares in the law firm for $140,000.00, which is the amount the husband argued as the value of his ownership interest in the law firm. Husband’s expert testified that the only “realizable benefit” husband would receive should he leave the Firm is that $140,000.00.
Wife retained a business appraiser who valued husband’s “goodwill”. Wife’s expert rejected the “realizable benefit” approach and, instead, used a “capitalization of earnings” approach. Instead, of valuing the husband’s interest based upon what he would be paid if he left the firm, the wife’s expert focused instead on how much money husband was making as an attorney at that law firm. Wife’s expert valued the husband’s “goodwill” interest to be $1,269,000.00.
The Arizona Court of Appeals found that the trial court erred when it used the “realizable benefit” approach to valuing the husband’s professional goodwill. Essentially, the Court of Appeals said the value of the husband’s “goodwill” as a successful attorney is not measured by what his law firm will pay him for his shares should he leave the law firm. Instead, the value of the husband’s “goodwill” is more accurately measured by how much more money he earns than his other attorneys.
This goodwill built by the husband during the parties marriage creates an expectation that he will continue to earn substantially more than other attorneys into the future. The community has a financial interest in the creation of that goodwill that occurred during the marriage.
Upon divorce, the husband will continue to financially benefit from that goodwill by earning substantially more than other attorneys who lack the same level of goodwill in their legal practice. So, basing a valuation on the excess amount of earnings the husband will earn in the future over and above what his peers earn becomes the basis for placing a value on that goodwill.
The Arizona Court of Appeals was very careful to point out a court cannot order a division of the husband’s future earnings after the divorce. Those earnings are clearly the husband’s separate property because they are earned after the divorce. Instead, the Arizona Court of Appeals indicated the community interest is, instead, based upon the increased earning capacity of the husband due to his efforts during the marriage. That increased earning capacity becomes the basis for the valuation of the husband’s goodwill and the community property interest in that goodwill.
The Arizona Court of Appeals then explained a scenario where the “realizable benefit” standard relied upon by the husband and his expert would have been appropriate. The “realizable benefit” standard is appropriate when valuing actual assets, such as computers, office equipment, and accounts receivable. But, the “capitalization of earnings” approach is appropriate when valuing the goodwill the husband had in his practice of law.
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Chris Hildebrand wrote this article about the valuation of a professional practice to ensure everyone has access to information about community property laws in Arizona. Chris is a divorce attorney at Hildebrand Law, PC. He has over 24 years of Arizona family law experience and has received multiple awards, including US News and World Report “Top Arizona Divorce Attorneys”, Phoenix Magazine “Top Divorce Law Firms”, and Arizona Foothills Magazine “Best of the Valley” award. He believes the policies and procedures he uses to get his clients through a divorce should all be guided by the principles of honesty, integrity, and actually caring about what his clients are going through in a divorce.