Divorce Valuation in Minnesota

By: G. Dennis Bingham

Introduction
Valuation for divorce purposes is one of the most frequent reasons that business appraisers prepare appraisals of closely held businesses and professional practices. Unlike gift, estate, and inheritance tax appraisals however, it is state law, not federal law, that governs divorce appraisals. Since divorce laws vary from State to State and trial courts have significant discretion in valuing property, valuing a closely held business or a professional practice for the purpose of divorce can be quite complicated. Accordingly, it is critical to know the law in the State in which the case is filed before preparing a divorce valuation in that State.

The objective of this article is to familiarize the reader with the major valuation issues associated with divorce valuations in the State of Minnesota. These include:

1. standard of value
   
2. valuation date
   
3. valuation methods
   
4. goodwill
   
5. valuation premiums and discounts

State Statute and Case Law
Minnesota statute 518.58 "Marriage Dissolution" provides only limited information for valuing a closely held business or professional practice. Two of the more significant valuation related issues covered in this statute are that Minnesota is an equitable distribution jurisdiction and that the value date is the date of the initially scheduled prehearing settlement conference, unless a different date is agreed upon by both parties.

With the lack of specific valuation information in Minnesota statutes, business appraisers must turn to case law for answers to specific valuation questions. Some of the more frequently referenced cases are: Rogers v Rogers 296 N.W. 2d 849 (Minn. 1980), Lowe v Lowe 372 N.W. 2d 65 (Minn. App. 1985), Nelson v Nelson 411 N.W. 2d 868 (Minn. App. 1987), Nardini v Nardini 414 N.W. 2d 184 (Minn. 1987), Burwell v Burwell 438 N.W. 2d 433 (Minn. App. 1989), Lyon v Lyon 439 N.W. 2d 20 (Minn. 1989), and Berenberg v Berenberg 474 N.W. 2d 843 (Minn. App. 1991).

Standard of Value
Generally, the appraisal assignment specifies that the subject business or professional practice be appraised at Fair Market Value. In the State of Minnesota, fair market value is the standard of value specified for preparing a business appraisal for divorce purposes. While the term fair market value has not been clearly defined by the courts, the Minnesota Supreme Court did adopt the principles of Revenue Ruling 59-60 in Nardini v Nardini.This definition appears to be accepted by appraisers and attorneys alike as the proper standard of value.
Special Considerations For The Business Appraisal In Divorce Situations: While the standard of value for divorce purposes is fair market value, Minnesota courts have modified or interpreted the traditional definition to include the following special considerations:

• The "market" is defined as the marital community, rather than the world at large.
  
• The "willing buyer" is viewed as the current owner, rather than a hypothetical third party purchaser.
  
• The business appraisal is made for equitable distribution purposes, rather than economic gain.
  
• There will be no sale of corporate assets to an outsider.

With the inclusion of these specific interpretations for divorce situations, the standard of value used by the courts begins to have characteristics similar to investment value. Investment value is the value to a particular investor. Accordingly, most divorce valuations have become hybrids. Valuations are initially based on fair market value standards, but on an individual basis,may include specific investor considerations.

Valuation Date
The valuation date is the date which the court uses to value marital assets. As noted in the state statute, the date initially scheduled for the prehearing settlement conference is designated as the court's valuation date. The court's definition of the valuation date can be problematic for the appraiser. Considerable time may pass between the date of the appraisal engagement and the first settlement conference. The appraiser may then have to update or revise the appraisal. In our experience, it saves both sides time and money if the parties can agree on a date of valuation: preferably a date that corresponds to the fiscal year end statements. The courts will accept an alternate date of valuation providing both parties agree to it.

Valuation Methods 1
The more commonly used methods for valuing closely held businesses are: single period capitalization, multiple period discounting, guideline publicly traded company, guideline privately held company and net asset value methods.The single period capitalization method is one of the most common methods for appraising a closely held business or professional practice, while the multiple period discounting method is increasingly being used in all types of valuations. The guideline publicly traded company method is advocated in Revenue Ruling 59-60, with the guideline privately held company used when applicable. The net asset value method is used frequently in divorce cases , as it is the most common method for measuring goodwill. When using the net asset value method, intangible asset value is frequently estimated by applying the excess earnings method.
Overall, it does not appear that the court requires or favors one valuation method over another. In short, the appraiser should use the most appropriate method based on the type of company, its size, the industry and other pertinent factors.

Goodwill
Under Minnesota marital property law the value of all property acquired during the marriage, including property developed through the use of personal skills and labor is considered marital property. However, post-divorce efforts and labor are not marital property. So if marital goodwill includes future earnings requiring post-divorce efforts to be realized, the marital property value of such goodwill should be adjusted downward to remove the value of such post-divorce efforts. This is true even though the earning capacity was developed during the marriage.

Valuation Premiums and Discounts
Upon arriving at an initial estimate of indicated value, appraisers may perform adjustments to reflect differences in value due to factors not considered in the first-stage of the analysis. Value adjustments may be necessary for differences in degree of control, differences in degree of marketability and key person discount, as well as post-divorce efforts.

An adjustment for difference in degree of control may or may not be necessary. An adjustment is required only when the methods used produce a value different from the interest being appraised. For example, if an appraiser is valuing a 100 percent interest that lacks no elements of control and each of the methods used produces a control-basis value, then neither a control premium nor lack of control discount is warranted.

The same concept applies to a lack of marketability discount. An adjustment is required only when the methods used produce a value different from the interest being appraised. However, based on Minnesota case law, a discount for lack of marketability may or may not be appropriate. If an appraiser accepts the premise that the standard of value is the marital community and assumes no change in ownership, there may be no justification for a discount for lack of marketability.

A key person discount involves a discount for dependence upon a key person responsible for a large part of a business' or a practice's success. This discount is normally the expected percentage decrease in equity value arising from the loss of a key person. In Minnesota, however, a business valuation for divorce purposes generally presumes that there will be no actual sale of the practice or business and that the current management will continue (Nardini v Nardini). For divorce cases, the Minnesota courts have applied a key person discount to ensure that one spouse does not get a forced share of the other spouse's future work and to ensure that one spouse does not benefit from a valuation method that would restrict the other spouse's future employment options (Rogers v Rogers).

Conclusion
While the majority of divorce cases do settle before trial, these cases are charged with the potential for emotional conflict. The spouse owning the business may believe that the non-owning spouse is trying to extract an increased settlement at his or her expense. The non-owning spouse may believe that he or she is entitled to the increased settlement and that the business owning spouse is trying to evade his or her responsibilities. If these beliefs persist, there is not likely to be a strong basis for a negotiated solution and litigation could result.

Accordingly, the appraiser must:

1. be familiar enough with the law in Minnesota (State Law and Case Law) to understand what is and is not legally possible
   
2. understand the facts of the subject case
   
3. apply the appropriate valuation methods for each assignment
   
4. maintain independence and objectivity

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