Miscellaneous
Few experiences in a valuation expert's professional practice provide as much personal challenge and mental stimulation as being an expert witness in a court of law. During divorce proceedings, often the most challenging issue is the valuation of marital property for distribution. These types of valuations are especially difficult for the assets of a business or business interest. This item concentrates on valuations of professional practices during divorce proceedings. The term "professional practice" includes businesses in the fields of medicine, law, engineering, and other professional services.
When a professional gets divorced, the value of his or her practice or business interest is usually included as a marital asset for the purposes of property distribution. Additionally, the income generated from the practice is generally used to determine alimony and/or child support payments. Valuation experts understand that because of differing laws, states use widely varying standards to measure an asset's value. The same follows for the recognition and measurement of the value of personal goodwill compared with practice or enterprise goodwill.
While the divorcing professional's attorney has a responsibility to serve as an advocate, the valuation expert has no such responsibility. He or she must remain independent and objective during the valuation engagement. When the valuation expert is a CPA, he or she is also bound by the AICPA Code of Professional Conduct and the AICPA Statement on Standards for Valuation Services (SSVS1). Objectivity requires the CPA/valuation expert to be impartial, intellectually honest, disinterested, and free of any conflicts of interest.
Determining the Standard of Valuation
Before beginning the engagement, the valuation expert must determine the appropriate standard of value that applies in the state or jurisdiction of the divorce. A family law attorney can inform the valuation expert of the appropriate standard of value to be used that reflects specific procedures in the particular state or jurisdiction. These standards include fair market value, fair value, investment value, and intrinsic value. Many states prefer fair market value but do not allow for the determination of goodwill. While these states want to follow the fair-market-value standard, they make no assumption that the business will be sold. This is not really fair market value.
Some states have begun requiring that business valuations be based on the intrinsic-valuestandard. SSVS1 says intrinsic value is "the value that an investor considers, on the basis of an evaluation of available facts, to be the 'true' or 'real' value that will become the market value when other investors reach the same conclusion." In other words, intrinsic value is the value of the business or business interest to its current owner.
Besides identifying the applicable standard of value, the valuation expert must also fully understand how that particular jurisdiction mandates the standard. Reliance on an incorrect standard of value could lead to an incorrect conclusion—causing a court to exclude the valuation report and testimony from evidence—and possibly later form the basis of a malpractice lawsuit.
Measuring Goodwill
SSVS1 defines goodwill as an "intangible asset arising as a result of name, reputation, customer loyalty, location, products, and similar factors not separately identified." Goodwill is generally separated into three categories: entity or practice goodwill, professional or personal goodwill, and goodwill that is transferable.
Practice goodwill is the value associated with the professional practice and is based on location, policies and procedures, staff retention, established patient/client base, and patient or client records. Practice goodwill is based on the assumption that clients or patients are likely to stay with the practice despite a change in ownership.
Personal professional goodwill assumes that the professional practice has a higher value because of the particular professional's knowledge, experience, skill, and reputation. The implication is that if the practitioner were to leave to go to another practice, his or her clients would follow.
Transferable goodwill is personal as it relates to the individual, but, over a certain period, it can be transferred to another person. These types of assets include personal relationships or specialized knowledge that could be transferred through employee training or development. It also includes contact lists or client or patient relationships that are transferable. The assumption is that, over time, this goodwill will be transferred to new ownership and typically would be coupled with a covenant not to compete.
The valuation expert must distinguish professional goodwill, practice goodwill, and transferable goodwill from one another. While court decisions in a majority of states have supported the notion that the other types of goodwill are assets of the marital estate of a professional practitioner during a divorce, most states do not consider professional goodwill a marital asset. However, in some states, professional goodwill is a part of the marital property even if it is not transferable. There is no "one size fits all" or "magic formula" for determining the amount of professional goodwill versus practice or entity goodwill versus transferable goodwill. Unfortunately, because there is no objective way to determine personal goodwill, the valuation expert must rely on his or her professional judgment.
In addition to assessing the value of tangible assets owned by the professional practice, the assessment includes other intangible assets besides goodwill, such as patient or client lists, medical or client records, and covenants not to compete. Often, the intangible value of goodwill and covenants not to compete is greater than the value of the tangible assets.
Determining the Valuation Date
State law determines the appropriate date on which to value the professional practice for divorce purposes. The valuation date may be the date the couple separates, the date the divorce action is filed, a date based on the trial date, or some other date. In addition, some states may determine the value of the practice included in the marital estate based on its value at the time of marriage and its value at the time of divorce.
Most divorce litigation disputes are settled outside the courtroom, but the emotional stress for the valuation expert stems from the apprehension that the valuation will end up in court (see Udell, Ch. 23, "When the Marriage Is Over, What Is the Practice Worth?" in BVR's Guide to Physician Practice Valuation (Business Valuation Resources 2012)). The valuation expert must be prepared to present complex financial and technical matters in a clear, logical, and concise manner. The consultant must be able to defend his or her conclusions and testimony under cross-examination by an often knowledgeable and usually hostile interrogator. In professional practice divorces, large gains and losses, both economic and personal, may result.
In professional practice divorce engagements, as well as other valuation engagements, there is no substitute for thorough homework and preparation. This includes understanding significant aspects of the case. It is vital to document supporting opinions and to be well-organized. Further, the expert must be able to communicate to the judge (or jury) the basis of his or her opinion and recall pertinent facts about the valuation engagement. These issues primarily relate to the use of appropriate standards of valuation, valuation methods, and discounts; presenting credible evidence; considering potential capital gain taxes; and classifying goodwill appropriately as either marital or separate property.
A successful valuation engagement in any divorce litigation requires sound judgment and well-documented conclusions. The valuation expert must be confident that the conclusions are objective, reasonable, and based on relevant facts and circumstances. In addition, the valuation expert must be confident that his or her conclusions are defensible in court. Many courts make their determination from previous decisions made in other states as well as their own. The successful valuation expert must have practical knowledge of relevant case law. This insight is likely to enhance the value of his or her services to referring attorneys.
EditorNotes
Michael Koppel is with Gray, Gray & Gray LLP in Canton, Mass.
For additional information about these items, contact Mr. Koppel at 781-407-0300 or mkoppel@gggcpas.com.
Unless otherwise noted, contributors are members of or associated with CPAmerica International.
