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Three Critical Issues To Consider Before Valuing A Professional Practice

Posted in Business Valuation, on Mar 2018, By: Mark S. Gottlieb

  • You have just picked up a new case.
  • Your client is a partner in a small or medium sized professional practice.  Maybe it’s a medical practice, an accounting office or even a law firm.
  • You were hired to serve as counsel in a shareholder dispute or even a divorce?  It really doesn’t matter.
  • What does matter is that your clients’ equity interest needs to be valued.

After a long afternoon with your client you realize there are a number of issues that may derail a quick resolution to this dispute.  Even now, you may have more questions than answers.  Setting aside those concerns specific to your clients’ practice and profession – there are a few issues you need to consider.

  1. What is the appropriate standard of value to be used?
  2. What is the appropriate date of the valuation? and
  3. How is goodwill to be determine? (if at all)

These issues are important to establish your client’s equity interest value, as well as other issues that may be germane.  For instance in a matrimonial setting spousal and child support needs to be determined.  In a shareholder/partner dispute income distributions and loans may need to be analyzed.

The following provides a short discussion of same.

1. Standard of value

The use of an incorrect standard (of value) can render a valuation report and the related testimony inadmissible. Fair market value and fair value are among the most common standards, but some jurisdictions now call for “intrinsic value.”

Fair market value as defined in Revenue Ruling 59-60 as “the price at which the property would change hands between a willing buyer and a willing seller when the former is not under any compulsion to buy and the latter is not under any compulsion to sell, both parties having reasonable knowledge of relevant facts.” The fair market value standard assumes that the price is transacted in cash or cash equivalents. Revenue Ruling 59-60, while used in tax valuations, is also used in many nontax valuations, such as for equitable distribution in matrimonial matters in New York State.

Revenue Ruling 59-60 also states that no general formula is applicable to the many different valuation situations, and that one should consider other factors in determining the subject company’s value.

In New York State the fair value standard is statutorily used in dissenting shareholder disputes and corporate dissolution matter.  In New Jersey, it is used in matrimonial matters.  The differences between fair market value and fair value is illustrated in the following table.

Fair Market Value Fair Value
Willing buyer Not always a willing buyer
Willing seller Not always a willing seller
Neither under compulsion Buyer & seller may be compelled
Typical, hypothetical buyer & seller Actual buyer & seller are known and the value is specific to them
A price that is equitable to both A concept of “fairness” to the seller, given the loss of the right to hold
Equal Knowledge of buyer & seller No such presumption
Adequate knowledge of buyer & seller No such presumption
Applies to majority or minority blocks Only comes into play for minority blocks
Applies for most federal tax valuation purposes The most common value standard in state shareholder oppression statutes

Intrinsic value is what an investor would consider to be the “real” value — and it’s generally the same as fair market value if other investors are likely to reach the same conclusion. It also can be understood as the value of the business to the current owner.

2. Valuation date

Timing can have a significant impact on value. In a corporate dissolution case the date is often a specific date of a particular shareholder action/event.  In a matrimonial matter, the valuation often coincides with the filing of the divorce.

3. Treatment of goodwill

Goodwill generally refers to a business’ intangible value.  Unlike tangible assets, such as equipment, machinery and furniture – intangible assets are those assets that you can’t necessarily see, feel and touch. Intangible assets include, but are not limited to brands, patents and client bases, to name a few.

Courts generally recognize two types of goodwill. Personal goodwill is linked to an individual’s knowledge, experience and abilities. Its value rests on the assumption that patients or clients would follow a practitioner to a new practice. Business goodwill can be separated from the practitioner. It relates to such factors as location, company name, assembled workforce, and established policies and procedures. Its value assumes the firm would retain clients and patients if the owner left.

Experts must understand the appropriate treatment of goodwill in a case’s venue.  About half of the states generally exclude personal goodwill from the marital estate. In those jurisdictions, only business goodwill may be included in the marital estate. Courts in other jurisdictions may either include all goodwill in the marital estate — or exclude it all, depending on relevant laws and legal precedent. It’s important to consider relevant state laws and applicable state case law in determining goodwill.

Most often these considerations are decided by statute or law, depending upon the venue of the case.  However, it does not preclude you, the attorney, from understanding their significance.

For more information about valuation issues  please browse through our earlier blog posts.

For a specific concern, contact us by phone (see numbers above) or by email msgcpa@msgcpa.com