Daycare’s Goodwill Excluded in TN Business Valuation Divorce

Tennessee business valuation law case summary – Daycare. Tennessee divorce and family law from the Tennessee Court of Appeals.

Alsup v. Alsup, 1996 WL 411640 (Tenn. Ct. App.)

The husband and wife, Ray and Judith Alsup, stipulated that Mrs. Alsup was entitled to a divorce on the grounds of  Mr. Alsup’s “inappropriate marital conduct.”  The husband was employed during most of the couple’s more than thirty year marriage.  The wife had operated a home day care business in the family home for about fifteen years.  In 1985, the day care business had grown substantially, and the parties moved it to a larger building that they had purchased.  In 1991, the parties incorporated the day care business, which was then being operated under the name “Ms. Judy’s Playschool.”  Mr. and Mrs. Alsup each owned 50% of the corporation’s stock.  Mr. Alsup served as the president, and Mrs. Alsup served as vice-president and director.

The trial court awarded the stock in the corporation to Mrs. Alsup, along with the vehicles and inventory that were located on the day care premises.  The trial court awarded the building in which the day care was located to Mr. Alsup.

The trial court valued the stock in the day care business at between $58,000 and $60,000.  In making that determination, the trial court noted that such a business had very little value without Mrs. Alsup working there.  Specifically, the trial court concluded that there was “no goodwill or going concern of this business without Mrs. Alsup running it….”  The trial court took special note of the testimony of several parents who testified that they would remove their children from the daycare if Mrs. Alsup was not personally working there.

In making its determination of value, the trial court largely followed the expert valuation testimony of Mrs. Alsup’s expert, Ray Bowling, C.P.A.  Mr. Bowling had testified that the fair market value of the stock was $58,160.00.  Mr. Alsup’s expert,  David Wood, C.P.A., testified that the fair market value was $280,000.00.

The trial court adopted a valuation formula set forth by the wife’s expert Mr. Bowling, although the formula itself does not appear in the Court of Appeals’ opinion.  The trial court had made two modifications to the formula.  Mr. Bowling had used $15,000.00 for the value of the officer salary.  The trial court found this figure “ridiculously low”, and instead changed this value to between $24,000 and $30,000.  Mr. Bowling had also used a value of $19,700 for nonbusiness expenses, but the trial court found no evidence to support this figure.

The husband appealed this ruling, and argued that the trial court erred in finding that the business had no goodwill value in the absence of Mrs. Alsup personally running it.

The Court of Appeals disagreed, and affirmed the trial court’s ruling.  The court cited previous cases involving professional practices, such as those of a physician, attorney, or accountant.  In all of those cases, the courts had held that goodwill of a professional practice could not be considered part of the marital estate.  The rationale behind these rulings was that the goodwill of such a business is really no different from the professional’s future earning capacity.  It adds no value to the business, separate from the individual’s personal reputation.  Therefore, it is not part of the marital estate.

This rationale had also been extended in prior cases to include sole proprietorships and partnerships of other types.  For example, the same rule had been applied in the case of a self-employed painter.

In his appeal, Mr. Alsup argued that this rule should not apply, because the daycare business was incorporated, rather than being conducted as a sole proprietorship or partnership.  The Court of Appeals found no reason to distinguish the earlier precedents on this ground.  The Court held that, just like a professional practice or other sole proprietorship, the corporation’s goodwill depended solely upon the personal reputation of Mrs. Alsup.  Therefore, the trial court did not err in failing to include any goodwill value for the corporation.

Mr. Alsup also argued that the trial court erred in excluding the valuation testimony of Mike Flannagan, who had been the corporation’s accountant.  The trial court had allowed Mr. Flannagan to testify as an expert on accounting, but not as an expert on appraising businesses.  Mr. Flannagan was not an expert on business valuation, nor did he have any experience in appraising businesses, other than a few occasions when his firm had expressed an opinion to a client as to the value of the client’s business.  Appraising was not part of the firm’s practice or specialty area.

The Court of Appeals refused to reverse on this ground.  It held that the trial court had not abused its discretion by excluding this testimony.  In addition, the Court held that any error was harmless. Mr. Flannagan’s proffered opinion as to the value of the business included an amount for goodwill, which the Court had already ruled was not proper.

The husband also argued that the trial court had erred in failing to take into consideration the value of the corporation’s inventory, such as cabinets, bookshelves, and food.  The court of appeals found this argument to be without merit, since the trial court had taken into consideration the inventory.  The Court of Appeals also noted that the trial court “had problems with Husband’s credibility.”

See original opinion for exact language. Legal citations omitted.

To learn more about Tennessee business valuation law, see Business Valuation in Tennessee Divorce Law. To learn more about the division and valuation of professional practices in divorce, see When Professionals Divorce in Tennessee: Valuing Professional Practices.

Miles Mason, Sr. JD, CPA handles complex divorce matters including business valuations and forensic accounting issues. View his professional biography listing books and articles published on business valuation and forensic accounting and seminars presented to lawyers, judges, business valuation experts, and forensic accountants. Miles Mason, Sr. authored The Forensic Accounting Deskbook: A Practical Guide to Financial Investigation and Analysis for Family Lawyers, published by the American Bar Association. The Miles Mason Family Law Group, PLC’s offices are located in Memphis, Tennessee and serves West Tennessee and Nashville.