Valuation Update

May 2016

Valuation Update

Current Family Law & Business Court Rulings


Miller, Welle, Heiser & Co., Ltd. Sanda J. Lang, CPA/ABV
4170 Thielman Lane (320) 253-9505
PO Box 159 Fax (320) 255-8939 Daniel S. Anderson, CPA, CVA
St. Cloud, MN 56302 1-800-450-0373
Jeffrey J. Gannon, CPA, CVA


Court Rejects Bright-Line Rule for Valuing Appreciation of Nonmarital Assets

Witt-Bahls v. Bahls
2016 Fla. App. LEXIS 1451

Active and passive appreciation of separate property is one of the most contentious issues in divorce cases, particularly in this age of entrepreneurship. Valuators know that much of the fight is over methodology—how to show conclusively that the increase in the value of the nonmarital asset is due to the efforts of the owner spouse or is due to market-related circumstances or the efforts of others in charge of the company. A recent case in Florida tackles the issue from the perspective of scope—how far should the nonowner spouse’s right to share in the increased value of nonmarital assets extend?

Husband owns stock but not the company. This appreciation case differs from the familiar scenario featuring a spouse who built his or her business prior to the marriage. Here, the husband began working for a big, privately held, international company prior to the marriage and at that time bought a large number of company stock with a bank loan. During his tenure at the company, he had some supervisory responsibility. But, even at the peak of his career, several layers of management were above him. Also, during his marriage, while working for the company, he was twice demoted. He was ultimately terminated, and his stock was liquidated. The shares sold for substantially more than the outstanding balance on the loan the husband had used to buy them.

Testimony from the husband’s CPA showed there were no payments on the loan other than interest payments.

The trial court determined the stock was separate property and its increase in value was passive and, therefore, not subject to marital distribution.

The wife appealed the ruling. The appeals court opinion states the wife asked for a rule “that all appreciation of the stock of a company for which a spouse works is a marital asset.” The court’s language suggests the wife either asked for a rule that would shift the burden of showing the appreciation was passive in nature and, therefore, not part of the marital estate to the stock-owning spouse or that the appreciation in value during the marriage was marital property as a matter of law.

Existing analysis stays in place. Either way, the Florida Court of Appeal rejected the wife’s proposition and used the opportunity “to address the passivity of appreciation of stock in a marriage.”

The court said with emphasis that, under the existing analytical framework, the increased value of stock from a company for which the owner spouse works can qualify as a marital asset and, thus, be subject to distribution. But it can also be a nonmarital asset. The crux of the matter is "whether the husband exerted the sort of ‘effort’ required to move the appreciation value from the nonmarital category to the marital one,” the court stated.

The Court of Appeal went on to say that cases that have found the appreciation was a marital asset typically involve a family-owned or family-run business in which the stock-owning spouse holds a significant position. In the instant case, neither of these “key features" was present, the appeals court found. The company for which the husband worked was not owned or operated by his family. Moreover, he played no significant role in the management of the company. At most, he was a “middle manager,” the court said. He did not contribute to the appreciation in the value of the company’s stock, and the increase never converted into marital property. The wife had no claim on it.

The court cautioned that the wife’s proposed rule might force trial courts into examining “how much of the increase in value of a multi-national corporation each and every hourly employee was responsible for.” Such an expansion of the concept of marital assets was the province of the legislature, the Court of Appeal noted, upholding the trial court’s ruling.

Affirmation of DLOM Rulings Augurs End to Shareholder Fight

Wisniewski v. Walsh Wisniewski II)

2015 N.J. Super. Unpub. LEXIS 3001)

After two decades of fierce fighting among the parties in this shareholder dispute involving a closely held trucking company, the parties renewed their attacks on the trial court’s findings regarding the applicable discount for lack of marketability. The selling shareholder reasserted his earlier claim that his expert’s prevailing discounted cash flow analysis sufficiently accounted for factors related to marketability. The buyers, in turn, contended the trial court erred in failing to adopt their expert’s considered DLOM analysis.

Circumstances justify DLOM use. Three siblings—a sister and two brothers—owned equal shares in a family trucking business that provided private fleets to customers across the country, with a particular focus on the retail industry. The sister’s suit against the younger brother set off an avalanche of other suits. Most critically for this case, in 1996, the younger brother filed an oppressed shareholder action claiming his two siblings tried to oust him from the company. Subsequently, the trial court found that the plaintiff younger brother in fact was the oppressing shareholder and ordered him to sell his interest either to the company or to the two siblings at fair value.

Both parties retained illustrious valuators. Ultimately, the first trial court set a value without conducting an evidentiary hearing—a move that triggered the parties’ first appeal. On remand, a different trial court heard expert testimony and largely adopted the discounted cash flow (DCF) approach the selling shareholder’s expert proposed. However, the court agreed with the buyers’ expert, who used a market approach to value the company, that a 15% key person discount was appropriate to account for the unique contributions the late board chairman (the older brother) had made to the company’s success.

Neither party approved of the resulting value determination, and both appealed the valuation a second time on various grounds. The appeals court affirmed nearly all aspects of the trial court’s findings, but it concluded that the valuation should have included a marketability discount.

It noted that a marketability discount was only applicable under “extraordinary circumstances” in forced buyout situations. Here it was justifiable. Under prevailing case law, “where the oppressing shareholder instigates the problems, … fairness dictates that the oppressing shareholder should not benefit at the expense of the oppressed.” The trial court specifically had found that the younger brother, i.e., the selling shareholder and minority owner, had engaged in conduct that harmed the other shareholders—the siblings defending against his suit—and that necessitated the forced buyout.

Accordingly, the appeals court remanded for a second time, ordering yet another trial court (two trial court judges had retired over the course of the litigation) to determine whether the prevailing DCF analysis embedded a DLOM and to set the applicable DLOM rate. (A further discussion of Wisniewski v. Walsh, 2013 N.J. Super. Unpub. LEXIS 724 (2013), as well as the court’s opinion, is available at BVLaw.)

Trial court reviews DLOM testimony anew. To answer the DLOM-related issues, a third trial judge reviewed the existing record. He found that, for his DCF analysis, the seller’s expert had built up a 12% discount rate from a number of components including a 7% equity risk premium, a 3.5% size premium, and a 4% company-specific risk premium. The latter accounted for the company’s closely held nature, its dependence on the older brother (since deceased) as a key manager, relative undercapitalization, and concentration of its customer base on the retail industry.

At the valuation trial, the seller’s expert explained that there was no reason to apply an independent DLOM because the company was successful and would likely take no longer to sell than other closely held companies of similar size and nature—typically about six to nine months—with assistance from “the right business intermediary.” He foresaw no danger to the other shareholders of losing liquidity during the marketing period. They likely would continue to benefit from the company’s generous cash flow. He noted that, in the years surrounding the valuation date, the business had distributed tens of millions of dollars to the shareholders.

He also explained that a marketability discount was more appropriate to valuing a minority share of restricted stock in a publicly traded company because owners have a difficult time selling their interests when the fluctuating market declines, making their interests relatively more illiquid. He pointed out that since he had accounted for certain risk factors in developing his discount rate he did not want to count those factors again by applying an independent discount for illiquidity.

Using a market approach to value the company, the buyers’ expert considered factors specific to liquidity such as the company’s size and closely held nature, its profitability, customer concentration in the retail sector, anticipated holding period, and dependence on the older brother’s stewardship of the company to determine the DLOM. He said that studies on the subject and legal precedent supported a 35% rate.

The new trial court started its analysis by answering the appeals court’s first question: Did the prevailing DCF analysis include a marketability discount? He found it did not. Even though the seller’s expert, in building his discount rate, considered many of the same factors the buyers’ expert considered for formulating his marketability discount, the seller’s expert did not adjust for marketability specifically. He “utilized [the factors] in a different way” than adjusting for a lack of liquidity, the trial court noted.

In contrast, in analyzing those same factors, the buyers’ expert “focused on the inherent illiquidity of closely-held companies and the anticipated holding period for a rational investor in his company,” the court found. There was no danger that applying a separate marketability discount resulted in double counting since it did not appear the experts accounted for the same risks relative to marketability, the court observed.

In answering the follow-up question—what the applicable DLOM rate should be—the trial court rejected both expert opinions: the 0% the seller’s expert proposed and the 35% the buyers’ expert used. The prior appeals court decision specifically required the use of a DLOM, the court noted. At the same time, it said that applying a 30% to 40% rate, in accordance with the leading decision in Balsamides v. Protameen Chems., 160 N.J. 352 (1999) (available at BVLaw), would unduly punish the seller and give a windfall to the buying shareholders. Other studies suggested a broader range, starting as low as 20%, the court said, depending on the equities in a given case. A relevant prior appeals court decision applied a 25% rate.

Just as the buyers’ expert did, the trial court on second remand also considered Judge Laro’s decision in Mandelbaum v. Commissioner, 69 T.C.M. (C.C.H.) 2852 (available at BVLaw) setting forth nine factors appraisers should weigh in determining a marketability discount. The court took particular issue with the buyers’ expert’s argument that the anticipated holding period in this case would be lengthy. It agreed with the seller’s expert who noted that given the company’s historical financial performance and growth it would not take long to sell the company and the shareholders would receive sufficient earnings while trying to sell. There were strong indicators of liquidity that the buyers’ expert failed to weigh appropriately, the court decided. It concluded that the equities in the case suggested a DLOM at the low spectrum of normal, that is, 25%.

End of the valuation game? Both parties challenged the trial court’s DLOM-related findings in a third appeal. The seller in essence claimed that since his expert considered all the factors related to marketability in calculating a discount rate for his DCF analysis, applying a separate DLOM based on the same factors amounted to double counting and improperly devalued the seller’s interest in the company. Also, considering none of the shareholders planned to sell their interest to a third party, a DLOM should not apply.

The buyers argued the trial court should have used the rate their expert determined based on relevant statements in Balsamides and his analysis along the lines of the Tax Court’s Mandelbaum decision.

The appeals court rejected both sides’ arguments. It first cleared up what it considered to be a misunderstanding on the seller’s part: that consideration of the same factors to build a discount rate for a DCF analysis and to apply a separate marketability discount inherently double counts the same risks. Not so, the appeals court said. The same factors affect the value of the company in two distinct ways. First, they account for uncertainty in receiving the expected income stream from the asset. Second, they affect liquidity by limiting the pool of interested buyers in a sale.

There was no dispute that the seller’s expert considered the relevant factors to assess uncertainty in building his discount rate. He also considered several factors related to liquidity, but not exclusively so, the appeals court observed. On the contrary, the expert was firm that the company had no liquidity problems that required special consideration. Therefore, the trial court’s finding that the expert’s discount rate did not embed a discount for lack of marketability was sound, the appeals court said. It dismissed the seller’s alternative argument that no DLOM was appropriate where no one contemplated a sale, noting that this issue had been decided in the earlier appeal against the seller.

The appeals court also upheld the trial court’s 25% marketability discount rate. The judge had a right to find a figure other than the figures the experts proposed, “so long as it was plausible, based on evidence in the record, and—in the final analysis—fair and equitable.” The appeals court added that neither side made a convincing argument for second-guessing the trial court’s “thoughtful and well-reasoned determination in this most difficult case.”

There is reason to think that, in upholding the trial court’s DLOM-related findings, the appeals court has brought this protracted conflict to conclusion.

This newsletter is a publication of Miller, Welle, Heiser & Co., Ltd.  We conduct business valuations for a variety of purposes including family law, litigation support, buy/sell agreements and estate planning.  For further information on our valuation services, please call Sanda Lang, Daniel Anderson or Jeffrey Gannon at 320-253-9505, or fax or email us at:

Sanda J. Lang, CPA/ABV


Daniel S. Anderson, CPA, CVA


Jeffrey J. Gannon, CPA, CVA


Miller, Welle, Heiser & Co., Ltd.

PO BOX 159

St. Cloud, MN  56302

Phone (320) 253-9505 Fax (320) 255-8939

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