After a twenty-two-year marriage, Ellen and James decided to divorce. When the parties married, James had recently graduated from college and immediately went to work in his family’s wholesale florist business, Union County Florist Supplies, Inc. (hereinafter referred to as “Florist”), wherein he eventually acquired a 47 ½ interest in the firm and becoming an officer. He has continually been employed by Florist. Ellen worked full-time as a dental assistant during virtually all of the marriage.
After a five-day trial, wherein both party’s respective accountants testified at length regarding Husband’s interest in Florist, the trial court adopted Ellen’s expert’s valuation of James’s interest in Florist and rejected James’s expert’s valuation. Accordingly, the judge awarded Ellen 40% of James’s interest, approximately $225,000 in equitable distribution.
James appealed the decision, mainly, he challenges the trial court’s refusal to credit evidence that his interest was a gift from his parents and to exclude from the marital estate that portion of James’s interest in Florist, representing the value of his shares as of the various dates when they were received from his father or his mother. James also challenges the trial judge’s adoption of Ellen’s expert’s valuation and rejection of James’s expert valuation particularly the judge’s holding that neither marketability nor minority discounts were appropriate in evaluating James’s interest in Florist.
The Appellate Division analyzed each expert’s report and noted that both experts took similar approaches to valuing the business. Each used a weighted average of the results of two valuation methods, the market approach (comparable sales of similar companies) and the capitalization of income approach (placing a present value on the anticipated future income stream). Both gave the income approach substantially more weight than the market approach. Still, Ellen’s expert stated that James’s interest was $561,926 and James’s expert stated that his interest was $238,000 as the incremental value of James’s shares to be included in the marital estate (excluding the shares he received as a gift from his parents). The magnitude of the disparity between the values these two experts placed on James’s interest in Florist clearly arose largely out of their respective approaches to the two legal issues: (1) the application of marketability and minority discounts and (2) gifting.
First, the Appellate Division addressed the gifting issue. The Appellate Division agreed with James when he asserted his first argument that the credible evidence in the record does not support the trial judge’s conclusion that James failed to prove that his interest in Florist was acquired by gift. The Appellate Division noted James’s mother’s and father’s testimony at trial when they asserted that they intended to give the business away to their sons and gave their shares away without compensation as part of their own estate plan and never intended anyone else, including their daughters-in-laws, to own the business. In light of that testimony, which was not contradicted by Ellen, the Appellate Division was satisfied that James met his burden of proving by preponderance of the evidence that his shares were gifts, and that their values when received must be excluded from equitable distribution.
Next, the Appellate Division addressed the applicability of marketability and minority discounts in valuing James’s interest in Florist. The Appellate Division noted the distinction between the two discounts: a minority discount adjusts for lack of control over the business entity on the theory that non-controlling shares of stock are not worth their proportionate share of the firm’s value because they lack voting power to control corporate actions and a marketability discount adjusts for lack of liquidity in one’s interest in an entity, on the theory that there is a limited supply of potential buyers for stock in a closely-held corporation. The general rule is that when determining the fair value of shares owned by a dissenting shareholder or for valuing shares in a court-ordered buy-out resulting from an oppressed shareholder situation, neither a marketability nor a minority discount should be applied absent extraordinary circumstances. Since neither scenario is applicable in James’s interest at Florist, and there are no extraordinary circumstances, Ellen’s expert was correct when he did not apply a marketability and minority discount to James’s interest. There was no evidence that James or his brother contemplated a sale of Florist. All of the evidence supports the likelihood that the business will continue under the present ownership for the foreseeable future. Likewise, James’s shares are owned by his two other brothers and even if he were to find himself at irreconcilable odds with his brothers, he is protected by the fair value rule itself. Meaning, he could force a statutory appraisal in which each bloc would be valued at a proportionate share of the whole. Accordingly, the trial court was correct when it rejected the applicability of marketability and minority discounts in valuing James’s interest.
In sum, if you are a self-employed business owner and there looms a valuation of your interest in your business, make sure you hire someone that is knowledgeable regarding the foregoing discounts. It will save you a lot of money and headache in the long run.
