NEW TN LAW in 2017: Discounts in Business Valuations Allowed

A change to Tennessee property division law in 2017 will have a huge impact many upcoming business valuations in divorce.

Business valuation in new Tennessee property division law

Business valuation in new Tennessee property division law

Dividing property in dissolution proceedings involves assessing many types of assets, including professional practices and small businesses. Whenever a business asset is owned partially or wholly by a spouse, a business valuation is necessary before the court can equitably divide any marital portion between the parties.

Placing a market value on closely held companies is seldom simple. Conflicting valuations are not unusual. Forensic accountants and Certified Public Accountants are experts who analyze and value business assets using various accepted approaches. Several business valuation methods are acceptable in court.

New Legislation Changes Business Valuation Factors

Public Chapter 309 was signed into law by Governor Haslam on May 5. The law went into effect on July 1, 2017. PC 309 amended Tennessee’s property division statute regarding valuation of closely held businesses or similar assets. This new subdivision was added to T.C.A. § 36-4-121(c):

(10) In determining the value of an interest in a closely held business or similar asset, all relevant evidence, including valuation methods typically used with regard to such assets without regard to whether the sale of the asset is reasonably foreseeable. Depending on the characteristics of the asset, such considerations could include, but would not be limited to, a lack of marketability discount, a discount for lack of control, and a control premium, if any should be relevant and supported by the evidence.”

Key Provisions Affecting Methods of Business Valuation

image: expert conducting business valuation

Forensic accountants, Certified Public Accountants, are business valuation experts

Breaking out some key language, this is what spouses with professional practices, closely held corporations, and similar assets should understand before settling on a valuation method for their business.

Under the amendment, the court should consider four aspects of business value evidence in determining an equitable property division:

  1. All relevant evidence pertaining to the business;
  2. Use of valuation methods typical for that type of business;
  3. Not to turn the valuation method on whether a sale of the business is reasonably foreseeable or not; and
  4. Depending upon actual business characteristics, that important considerations in placing a market value on the enterprise may include: 1) Lack of marketability discounts (see the Barnes case discussed below); 2) Discounts for lack of control of the business; and 3) control premiums paid by a buyer over the market price to exercise a controlling share in the business.

Business Valuation Methods Matter

The new business valuation law will affect cases with facts like those in Barnes v. Barnes (Tenn. Ct. App. 2014). In the Barnes’ divorce, filed in 2009, the property division was based in part on valuation of the husband’s Shelbyville professional practice. Married 25 years, they had acquired substantial assets including husband’s dental practice.

Professional dental practice valuation

Professional dental practice valuation

The trial court divided the marital property nearly equally. After various rulings on post-trial motions, the wife appealed. Among other things, she argued that the trial court had erred in the property division because the business valuation of the dental practice was incorrect (too low). And that the trial court’s 15% lack of marketability discount on the value of the professional practice was erroneous.

Briefly, the dental practice was a professional corporation solely-owned by husband. It employed another dentist and nine full-timers. In 2003 he rejected a $913,000 offer to sell. He had listed the practice for sale at $1.2 Million. He signed a net worth statement of $1 Million in 2006. From 2005 to 2009, annual revenue was between $1.48 and $1.74 Million.

Wife’s expert: Her business valuation expert utilized three valuation methods and averaged the results for a recommended practice value. He added goodwill (deducting husband’s personal goodwill (separate property) from enterprise goodwill (marital property)); and placed a $678,179 value on tangible assets and enterprise goodwill. However, the expert testified he did not consider practice debts or cash and accounts receivable. This valuation expert applied the summation of assets method, gross revenue multiplier method, and capitalization of earnings method of business valuation.

Husband’s expert: His expert compared value using an asset-based approach and an income-based approach. The business had a deficit net worth, no goodwill value, and warranted a 15% discount due to lack of marketability. Using the capitalization cash flow method, he gave it a $50,000 value.

Conflicting valuation evidence ranged between $678,179 (wife’s) to $50,000 (husband’s) with the greater weight of the evidence given husband’s expert. The trial court valued the dental practice at $386,343. It then applied a 15% lack of marketability discount ($57,951) for a final value of $328,392.

The Court of Appeals affirmed the trial court’s business valuation and expert credibility determination, but rejected the 15% lack of marketability discount. The wife was awarded $28,975.50, half the discounted amount of $57,951.

Barnes Overturned Legislatively

Could facts like those in Barnes provide a different result today? Yes. When PC 309 became law, a property division case with facts similar to Barnes would result in affirming the lack of marketability discount. But only if relevant and supported by the evidence presented at trial.

Essentially, PC 309 reversed Barnes legislatively. Today, if the evidence supports doing so, then the trial court has discretion to adjust the value by discounting for lack of marketability or lack of control, or by adding control premiums. And without regard to whether a sale of the business is reasonably foreseeable.

Could the courts extend the property valuation amendment to real estate as a “similar asset” to a closely held business? Projecting possible application of PC 309 to future fact patterns, it might allow reversal of current caselaw on real property valuations in divorce, too, at least in some circumstances. Current caselaw does not allow a discount to be applied for cost of sale when no sale of the real property is reasonably foreseeable or intended. We will have to wait and see whether the cost of sale discount will follow the path of the lack of marketability discount in Tennessee’s courts.

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