Value of luck is key to big-money divorce case
When Jed Clampett went to shoot at a critter, he missed his target but tapped into an oil gusher. Old Jed, the lead character in TV’s ”The Beverly Hillbillies,” got rich and moved to the land of swimming pools and movie stars. The “Jed Clampett defense” is what some court pundits are calling the position an oil billionaire took in his recent divorce case, according to an article in The New York Times. The defense is based on the “active versus passive appreciation” concept in divorce law.
Luck versus skill: In some states, if a spouse owns an asset before the marriage, the increase in value of that asset is not subject to division if the increase was due to “passive” appreciation, that is, if the asset’s value increases due to factors outside of either spouse’s control. But if the value increases due to the efforts or skills of a spouse, it is considered “active” and is thus subject to division in a divorce. So the question comes down to luck versus skill.
Harold G. Hamm, chief executive and founder of Continental Resources, claimed that it was luck that brought him the bulk of his fortune, which amounted to $18 billion at one point. He says his skills and efforts were responsible for less than 10% of his personal and corporate success. His wife claimed it wasn’t mostly luck—his skill was responsible for more than 90% of his wealth. The judge in the case, which took place in Oklahoma, largely sided with the husband and awarded the wife about $1 billion. Both sides are appealing.
The parties managed to have the court seal the proceedings, so details of the case are not available, according to Sylvia Golden, executive legal editor at Business Valuation Resources. “The subject is very interesting—active versus passive appreciation—and it does not come up that often. I thought we might see it more because of the huge amounts of money involved in tech start-ups and similar enterprises. But it may also be the case that many of the entrepreneurs make prenuptial agreements that take care of the issue.”
Trying to quantify active versus passive appreciation can be very challenging. The small amount of academic research on this topic has “often found that broader market forces often have a bigger impact on a company’s success than an executive’s actions,” says the Times article.
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New twist to debate on discounts in fair value proceedings
Much of the valuation community’s attention in the past few months has focused on New York fair value proceedings. Now the Utah Supreme Court adds more fodder to the discussion with a decision that rejects the lower court’s reliance on precedent that prohibits deductions for lack of marketability and tax liabilities.
‘Everything for sale’ strategy: A Utah company involved in land development and other activities ran into financial problems and in 2000 decided to wind down operations by selling its assets. From then on, “everything [was] for sale,” a company representative said. Four years later, the company’s board approved a share-consolidation transaction that resulted in the buyout of all shareholders, except for the company’s president. Based on a fairness opinion, the company offered $5,250 per share. Two “activist” investors dissented. They claimed their shares were worth nearly $32,000 per share. The company asked the court for a fair value determination.
The district court appointed an appraiser who prepared an initial valuation using the asset approach. Besides the real estate, the company also owned oil and gas royalty interests and a minority interest in another realty company. In calculating the value of each asset, the appraiser applied deductions for transaction costs and built-in capital gains (BICG) taxes and discounts for lack of marketability (DLOMs).
The district court discredited the valuation and ordered him to do another one. Controlling case law prohibited the use of DLOMs and tax-related adjustments, it said. Specifically, in the Hogle case, the state Supreme Court held "that discounts at the shareholder level are inherently unfair to the minority shareholder who did not pick the timing of the transaction and is not in the position of a willing seller." The district court also noted that Hogle “did not carve out any exceptions for asset-level discounts.”
The appraiser defended his initial valuation but agreed to amend his report, saying appraisers were “not attorneys and [were] not qualified to interpret Utah law.” The revised valuation indicated a share price of $10,722—twice the amount the company had offered. The appraiser later disavowed the amended appraisal, which, he said, conflicted with “generally accepted appraisal techniques.”
Two kinds of discounts: The company asked the state Supreme Court for review, pointing out: “There is accordingly no dispute that the vast majority of [the company’s] value as of the valuation date, and its only realistic means of generating earnings, came from its assets.”
The state’s high court found that the district court had misapplied state law and also had relied on noncontrolling law from other jurisdictions. In disallowing the deductions, it erroneously relied on Hogle, a case that dealt with shareholder-level discounts, whereas the present case dealt with asset-level discounts. According to the state Supreme Court, the district court’s ruling represented an “unwarranted extension” of Hogle, which nowhere addressed asset-level discounts. The rationale that applied in Hogle, but not here, was that it would be unfair to dissenting shareholders who “are unwilling sellers with no bargaining power” to penalize them for their shares’ lack of marketability or lack of control.
According to the state Supreme Court, “These concerns are not at issue where a company discounts the value of an asset that it intends to sell for reasonable transaction costs.” Here, the company’s “undisputed” business strategy—which was in effect long before the triggering event—was to hold and sell its real estate. Therefore, it was appropriate to consider reasonable transaction costs, including broker commissions and closing costs, arising from the sale. Moreover, these costs equally would have affected the majority and minority shareholders.
The state Supreme Court also allowed a BICG deduction given the company’s business strategy. “Deductions for trapped-in capital gains are appropriate where the taxes are reasonably foreseeable in the ordinary course of business.“ Consequently, it vacated the district court’s ruling and remanded for new fair value proceedings consistent with its opinion.
Takeaway: In this dense opinion, the Utah Supreme Court rebukes the lower court for its lack of understanding of valuation techniques, forcing an experienced appraiser to perform an erroneous calculation, and applying valuation-related legal principles indiscriminately.
Find an extended discussion of Utah Resources International, Inc. v. Mark Technologies Corp., 2014 Utah LEXIS 216 (Dec. 23, 2014), in the March edition of Business Valuation Update. The court’s opinion will appear soon at BVLaw. Note that a digest and the opinion for Hogle v. Zinetics Medical, Inc., 2002 UT 121 (2002), are also available at BVLaw (subscription required).
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Future guidance for ESOP appraisers
Last week’s BVWire reported on the Department of Labor’s apparent dropping of the “appraiser as fiduciary” rule with respect to valuations of employee stock ownership plans (ESOPs). However, this issue is not completely put to rest. According to the AICPA, “the DOL has expressed interest in working with the appraiser community to improve guidance for ESOP appraisers.”
Uproar: The AICPA, among other groups, sprang into action in 2010 when the DOL proposed the rule that would have included valuation providers in the definition of a fiduciary under the Employee Retirement Income Security Act (ERISA). In response to the valuation community’s concerns, the DOL withdrew the proposed rule in 2011. A new definition of “fiduciary”—absent the inclusion of appraisers—is expected to be released soon.
“The AICPA believes the removal of valuation providers from the proposed rule is a positive outcome,” it says in a report. The organization feels that a better solution is to implement rules similar to those developed by the IRS where individuals performing valuations for qualified plans would be required to have credentials and follow valuation standards. The AICPA “looks forward to working with the Department to craft a solution that protects plan participants while not imposing an undue burden on plans or valuation providers.”
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Buy-sell agreements can be embedded in multiple places
Buy-sell agreements are an integral element in exit planning, which is now a topic of great interest in the valuation community. However, provisions of buy-sell arrangements can be included in a number of different organizational documents, such as shareholder agreements, operating agreements, partnership agreements, and bylaws.
Sneak peek: Attendees at the February 12 BVR webinar, Buy-Sell Agreements, will receive an advance copy of an article written by the webinar’s presenters, Brian D. Burns and Chris Mitchell, both with Dixon Hughes Goodman. The article will appear in the March issue of Business Valuation Update. It provides an overview of the documents that govern the operation of businesses and the importance of buy-sell agreements in valuation services.
During the webinar, Burns and Mitchell will focus on the valuation implications of buy-sell agreements, including factors that influence value and selecting the method to determine the purchase price. The speakers will also discuss how the courts view buy-sell agreement disputes, and they will give practical examples of disputes and eventual outcomes.
For more details on the webinar and how to register, click here.
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Legal marijuana biz is a growing opportunity
Oregon’s recent passage of Measure 91, which legalized recreational use of marijuana in the state, emphasizes the growing opportunities for businesses of all kinds. Expect to see retail shops open in the state soon after recreational use becomes legal this July.
Canna-do: “Measure 91 is a ‘business-friendly piece of legislation,’” attorney Hilary Bricken told a full house at the recent Oregon Marijuana Seminar. “However, being a start-up is difficult, and being a start-up in the canna industry is extremely difficult,” she advised. It is imperative to have an accountant and lawyer to be serious in this business.
And, as with other businesses, there is real money to fight over when the owners divorce a spouse, dispute a partnership agreement, gift shares, or sell the enterprise. In terms of valuation, it can be particularly challenging in this industry, which has a short history, a high level of risk, high volatility, and a complex, quickly evolving regulatory structure. These issues—and more—are covered in a recent BVR special report, Marijuana Dispensaries: A Budding Industry Brings Opportunities and Challenges for Business Appraisers.
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Comprehensive BV training in Amsterdam
There’s a strong international demand for business valuation education and accreditation. Appraiser groups in countries around the world are organizing and participating in the accreditation process through the International Institute of Business Valuers (IIBV). The American Society of Appraisers along with the IIBV and Benelux Investment Institute offer a full set of courses throughout 2015 in the Netherlands, providing opportunities for Dutch business appraisers and others to participate in ASA’s business valuation accreditation process and the path to becoming a member. The courses are:
- Introduction to Business Valuations (IIBV 101)
- International Cost of Capital (IIBV 102)
March 19-22 (back-to-back with IIBV 101)
- Business Valuation Case Studies (IIBV 103)
- Advanced Topics in Business Valuation (ASA 204)
September 17-20 (back-to-back with IIBV 103)
For more details, click here. You can also contact Andrew Pike, ASA managing director, at +31 (0)70 221 0343; email@example.com.
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BV movers . . .
People: Courtney Sparks White, head of the business valuation and forensic team, was named partner at Clarus Partners of Columbus, Ohio … Mark Lechtenberg and Josh Buckingham were promoted to tax principal at TD&T CPAs and Advisors of Iowa … Lee McGee has joined the Atlanta office of Warren Averett as a member and managing director of the firm’s Transaction Advisory Group.
Firms: AC Lordi, a firm in Pennsylvania that is a leading provider of accounting and risk management consulting and executive search, is adding valuation to its array of services … The Los Angeles investment bank Houlihan Lokey has opened an office in Sydney, Australia, and will be jointly led by Nicholas Rowe, Oscar Ludwigson, and David Tozer. Initially, operations will focus on advising clients on corporate finance and restructuring matters … KNV Chartered Accountants LLP, the eighth largest accounting firm in British Columbia, Canada, announced its merger with MNP LLP as of Feb. 1, 2015 … Applied Business Strategy, a Cleveland-based consultancy practice, has acquired the Cleveland accounting firm Cohen & Co.’s litigation services and business valuation practice.
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Any appraiser who deals with family limited partnerships should tune in to this upcoming webinar, which is devoted to special challenges in this area.
Valuations for Complex FLPs (February 24), featuring Bruce Johnson (Munroe, Park & Johnson Inc.). Once an appraiser adopts a more analytical method for valuing FLPs by using the income and market approaches, certain types of partnerships may be considered complicated. This webinar will focus on valuing complex FLPs, including multiple-asset FLPs, oil and gas FLPs, and non-income-producing FLPs, using case studies. Plus, Johnson will share his opinions on issues such as how to handle FLPs that own privately held stock, other partnership interests, venture capital funds, and promissory notes.
Other upcoming webinars of interest:
Important note to webinar attendees: To ensure that you receive your dial-in instructions to BVR’s training events, please make sure to whitelist firstname.lastname@example.org.
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