Articles By Lorraine Barton

Case Shows Power of Buy-Sell Agreements

A recent court decision demonstrated the power of buy-sell agreements. Photo by Matthew Henry on Burst

A buy-sell provision can help ensure an orderly transaction when one shareholder wishes to leave a business. It can dictate the manner in which an owner’s interest changes hands, as well as the price.

The enforcement of one such provision was the point of contention when the shareholders of a family-owned automotive repair business in Nassau County recently faced off in court.

Tabs Motors of Valley Stream Corp. was owned by four siblings, each of whom held 50 shares of common stock. The siblings signed the shareholders agreement in December 2013, after allowing more than a year for consideration of its terms. The agreement featured a buy-sell provision that, among other things, would be triggered upon the filing of a motion to dissolve the company. 

Buy-sell agreements

Buy-sell provisions spell out the terms under which an owner’s share of a business may be reassigned when they leave the company. They often provide for some combination of redemption, in which the company is required to repurchase the interest, and cross-purchase, in which the remaining owners are permitted to buy it. Such provisions are often intended to prevent ownership from falling into the hands of outside parties. If designed properly, they can reduce the likelihood of controversy when a shareholder decides to leave the company.

Tabs Motors’ shareholders agreement (as cited in the decision) includes a buy-sell provision stating that “if any shareholder files a petition to dissolve the Corporation; … the Corporation firstly, and then the other Shareholders shall have the option to purchase all, but not part of the shares owned by such Shareholder.”

On October 29, 2019, two of the shareholders of Tabs Motors, Michael Louros and the Estate of Connie Collins, filed a petition for dissolution of the corporation. The filing triggered the buy-sell provision in the shareholders agreement. The corporation held a shareholder meeting on December 16, 2019, at which the two nonpetitioning shareholders voted to have the corporation exercise its option to purchase the shares held by the petitioners. The shareholders agreement excluded the petitioning shareholders from voting.

The closing was set for February 11, 2020. The purchase price was set by the shareholders agreement at $5,250 per share, nearly twice the value determined by an appraisal of the company in 2011, two years before the execution of the shareholders agreement.

In response to the petition for dissolution, Tabs Motors filed a counterclaim seeking to enforce the sale of the petitioners’ shares. Supreme Court Justice Robert Reed granted summary judgment in favor of Tabs Motors, ordering the sale of the interests. 

Justice Reed rejected the petitioners’ contention that the shareholders agreement was unconscionable, noting that it applied equally to any shareholder who petitioned for dissolution and that the parties had more than a year to review the agreement and receive counsel prior to signing. He rejected the claim that the valuation provided in the shareholders agreement was stale, pointing out that it was double the 2011 valuation and that it had been affirmed in 2018 in the probate of Connie Collins’ estate.

Finally, Justice Reed rejected the petitioners’ assertion that the other owners had breached their fiduciary duties, noting that even if the claims were legitimate, “they would not invalidate the buy-sell provision. The buy-sell provision is still enforceable.”

Parting thoughts

The ruling in Estate of Connie Collins v. Tabs Motors demonstrates the durability of buy-sell provisions written into owners agreements. That’s why it is vital to give due consideration to the wording of such agreements. For instance, language that calls for an appraisal in the event of a controversy can help ensure equitable treatment of all interests. For more information on buy-sell agreements or other valuation matters, please contact the trusted professionals at Advent.

The case is The Estate of Collins v. Tabs Motors of Valley Stream Corp. You can read the decision here. Read additional Advent blog posts on buy-sell agreements here and here.

Divorce Case Spotlights Complexities of Double-Dipping Analysis

Courts sometimes have difficulty determining an appropriate allocation of assets in a divorce.

The division of assets in a divorce is vital to the financial futures of the spouses. A fair division of assets is required under New York state equitable distribution law. For many couples, a professional practice (think doctor, lawyer or accountant) or a business is a key asset in their divorce. While not a New York case, Oudheusden v. Oudheusden was an interesting read for those of us seeking to better understand this topic. 

In this Connecticut case, the husband defendant, whose marriage had been dissolved, appealed to the Appellate Court a judgment of the trial court. The trial court had awarded his wife $18,000 per month in permanent alimony that could not be modified or changed in duration or amount. The trial court found the husband’s gross annual income of $550,000 was completely derived from his two closely held businesses, which were valued at $904,000.

As part of its financial orders, the court awarded 50 percent of the fair market value of the two businesses to each party, ordering the defendant to pay the plaintiff $452,000. The court awarded 100 percent ownership of both businesses to the husband. 

Income vs. Profit

On appeal to the Connecticut Appellate Court, the husband claimed that the trial court impermissibly double-counted his income by considering it both for the purpose of valuing his businesses and in making its maintenance award.

The Appellate Court reversed in part the trial court’s judgment and remanded the case for a new hearing on all financial issues. The Appellate Court concluded that the trial court had abused its discretion in failing to issue equitable orders and to consider, with respect to its maintenance award, the possibility that the husband, who was 58 years old at the time of the dissolution and had a history of alcohol abuse, could become ill or might want to retire, or that his businesses could fail to prosper through no fault of his own.

The Appellate Court further determined that the trial court had engaged in double-counting. The plaintiff wife then appealed to the Connecticut Supreme Court. 

Double Reversal

The judgment of the Appellate Court was affirmed by the Supreme Court with respect to its determination regarding the trial court’s financial orders but reversed with respect to its determination that the trial court improperly double-counted the value of the defendant’s businesses for purposes of the property division and alimony awards. The case was remanded to the Appellate Court with direction to remand the case to the trial court for a new hearing on all financial issues.

The case is Oudheusden v. Oudheusden, (SC 20330, Connecticut Supreme Court, Apr. 27, 2021). Read the decision here. For additional blog posts on divorce-related topics, click here, here or here.

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If you require assistance with the valuation of a business or determination of reasonable compensation in a matrimonial matter, please contact Advent for trusted guidance.  

Divorce Case Highlights Value of Goodwill

Photo by Nosiuol on Unsplash

While not a New York case, a recent divorce case in Delaware Family Court sheds new light on an old precedent for the treatment of enterprise goodwill in a sole proprietorship.

The couple in A.A. v. B.A. married in 1979 and divorced in February 2017, but the case lingered, with a decision regarding the valuation of the husband’s financial advisory practice, a sole proprietorship, coming in October 2020.

Both spouses hired experts to value the business. The experts reached widely divergent conclusions, with the husband’s expert valuing the business at $255,000, while the wife’s arrived at a value of $3,488,0000 to $3,500,000.

The court rejected the report by the husband’s expert, taking issue with both its failure to consider the business’s goodwill and its reliance on a flawed asset approach.

“From the outset, husband’s expert’s opinion was limited by his belief that Delaware law was settled that there could not be good will in a sole proprietorship,” reads the decision.

The husband’s expert had relied on a 1983 Delaware Supreme Court decision. In E.E.C. v. E.J.C., (457 A. 2d 688, Del. 1982), the court had rejected the consideration of goodwill in the valuation of a sole practitioner’s law practice. According to the decision in A.A. v. B.A., the husband’s expert took that oft-cited decision as an indication that Delaware case law does not permit the use of goodwill in valuing sole proprietorships under any circumstances.

The court rejected this premise: “The court notes that husband’s business in the present case is not a law firm and the practice and means of generating income are different. The court does not read E.E.C. as stating every sole proprietorship in every case has no professional good will.”

The court agreed with the wife’s expert, who assigned 5 percent of the total goodwill to the husband based on the value of his noncompete agreement, and the remaining 95 percent to the business. The court said both experts agreed that, if the husband could transfer goodwill such that he could transfer to a buyer his client base and stream of income, or even 95 percent of his stream of income, he could receive about $3.5 million for the business.

Misassessed assets

The court also took issue with the husband’s expert’s asset approach, which did not consider income earned but not yet paid to the business as of the separation: “Husband continued to run the business and the value receive[d] by husband through receivables, work in process or residual commission tails was well beyond the amount placed on it by husband’s expert. This would probably explain why the husband himself placed a value of $10 million on the business in his financial statements.”

The decision notes that, between the date of separation and late 2019, the husband extracted more than $4 million from the business, including commissions for work done during the marriage. This included a $600,000 commission received in 2018 that had been in the making for perhaps three years, according to the husband’s testimony.

The wife’s expert used a weighted combination of the income approach (capitalized income method) and market approach (transaction and guideline public company methods). The court relied on the wife’s expert, determining that the business’s value was $3,488,000.

The case is A.A. v. B.A., CN16-05018 (Del. Fam. Oct. 9, 2020). Read the decision here.

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If you require assistance with the valuation of your business in a matrimonial matter, please contact Advent for trusted guidance.

Valuing Personal Goodwill

We recently have been involved in a number of valuation assignments which involved the allocation of personal and enterprise goodwill.

In valuing a business, the term “goodwill” may have different meanings. In many cases, goodwill is used as a catch-all for all intangible assets of a business. However, from a valuation perspective, goodwill is, “the excess value of an enterprise beyond the value attributable to the entity’s identifiable net assets.”

In this blog article, we approach goodwill in the more general sense, referring to any and all value of a business that is not attributable to the business’s current assets (cash, accounts receivable, etc.) or its tangible assets (inventory, furniture, equipment, etc.). Overall goodwill can be further broken down to enterprise goodwill (also known as “business goodwill”) and personal (or professional) goodwill.

  • Enterprise goodwill is derived from characteristics specific to a particular business, regardless of its owner or employees working within the business.
  • Personal goodwill is value associated with a particular individual working within the organization, rather than the characteristics of the business itself.

Some of the indicators of enterprise and personal goodwill are as follows:

From a valuation standpoint, one might question why the division between personal and enterprise goodwill matters. In fact, it depends on the purpose of the valuation, in many cases goodwill (personal or enterprise) is not allocated from overall company value. The total goodwill of the business is merely incorporated as part of its total enterprise value.

For example, for a valuation prepared for gift or estate tax purpose we usually determine the company’s total value as a going concern. The resulting value often exceeds the value of the company’s tangible and monetary assets, indicating the existence of goodwill. However, the resulting goodwill is rarely further analyzed and allocated into the enterprise and personal goodwill.

Similarly, under GAAP accounting rules, goodwill on the balance sheet represents the premium for buying a business above and beyond the identifiable assets of that business. Accountants take the purchase price and subtract the fair value of company’s identifiable tangible and intangible assets. What is left, and cannot be allocated, is goodwill. For this purpose, personal goodwill is not considered a separate asset, except as it may be captured in the value of a non-compete agreement.

In other cases, like the sale of a business, the distinction between enterprise and personal goodwill could matter. One such case would be to assist in structuring a business transaction. In an acquisition, it may be beneficial to segregate out personal goodwill, since a buyer paying proceeds directly to the seller specifically for the personal goodwill (rather than as proceeds for the value of the company).

Another reason for delineating personal and enterprise goodwill pertains to the process of evaluating the total consideration to be paid by the purchaser of a business. A buyer will be willing to pay only for the portion of the intangible value of an enterprise that can be transferred upon consummation of the transaction. Based on the characteristics detailed above, this often results in only enterprise goodwill continuing with the purchaser. However, a transaction can be structured such that a portion of the personal goodwill, and its associated benefits, can transfer to the acquirer. This is often completed through the use of employment agreements.

Once the existence of personal goodwill has been identified, the next step is to calculate its value. This is generally accomplished using the “with and without” method.

The with and without method of determining personal goodwill is an income approach that attempts to value a business using two scenarios:

  • with the particular individual continuing to work in the business, and
  • without the individual’s continuing involvement.

The with and without method utilizes cash flow models to project the revenues, expenses and net cash flows that a business would expect to realize under each scenario. Under the “with” scenario, the projections usually reflect the overall assumptions and cash flow projections for the business “as is.” As a result, this scenario includes the value attributable to personal goodwill of the subject key individual.

The “without” scenario assumes that the enterprise would earn less revenue due to the loss of the subject individual. While the model may also assume that the subject company could hire a replacement for the key individual, most experts assume that it would take several years until the new individual could generate revenues and earnings comparable to those generated by the departing individual. Therefore, this scenario reflects a lesser value due to the entity’s loss of involvement by the individual.

AICPA and Partners Develop New Valuation Credential

The American Institute of CPAs has partnered with the American Society of Appraisers and the Royal Institution of Chartered Surveyors on a new credential for financial professionals who provide fair value measurement services.
The AICPA, ASA and the RICS began working together on developing a single credential that offers a more consistent framework for fair value measurement. The organizations are striving to be sure financial professionals have the necessary training, qualifications, experience and expertise to perform the work. They released a proposed framework in 2016.

Financial professionals who receive the new Certified in Entity and Intangible Valuations (“CEIV”) credential would need to follow new uniform guidance on how much documentation is necesssary to support their fair value measurement results in company financial statements when they are producing valuations of entities and intangible assets such as trademarks, patents and technology, customer sales lists, and non-compete agreements.

The uniform guidance for the credential specifies the level of documentation necessary to enable investors, auditors and regulators to understand more easily how fair value measurement has been used to determine the values of businesses and intangible assets. The CEIV credential also requires regular monitoring of credential holders to make sure they’re following the new guidance.

To get the new credential, financial professionals need to meet certain eligibility requirements determined by the AICPA, ASA and the RICS, in collaboration with the Appraisal Foundation and the International Valuation Standards Council, which also helped develop the new credential. Those requirements include demonstrating competencies in valuation and fair value measurement through training and assessments, along with passing a two-part CEIV exam that will be introduced this year.

We here at Advent are always trying to proactively respond to clients’ needs and are watching the developments closely and, if necessary, will be obtaining the new credential.

Divorce and Business Valuation

Understanding the different facets of both divorce law and business valuation is crucial if either spouse owns a closely held business. When it comes to divorce, that ownership interest will be classified either as a “separate” asset and not included in the marital estate for equitable distribution, or it might be classified as a “marital” asset that the court would include in marital asset distribution. In some circumstances a portion of the value could be deemed separate and the balance marital. Accordingly, it becomes necessary to value the business. The courts generally have wide discretion to decide what is equitable when dividing property.

For the purpose of equitable distribution, the valuation of a business will require numerous determinations. For example:
• What should the date of the valuation be?
• What methods should be used to determine the value?
• What does the business own?
• Who does the business owe?
• What is the business’s real profit?

This post will discuss some practical recommendations to consider when determining business profits. While measuring the profitability of the business is only one of the requirements for determining value, in the matrimonial litigation context, it is often one of the more contested issues because profits not only impact the value of the business but may also impact spousal maintenance determinations. There are numerous ways in which “profit” can be calculated because businesses differ greatly on how “revenues” and “expenses” are recorded in their books. Consequently, one needs to carefully read the business’s financial records and books so that the true profit can be accurately determined.

If one spouse owns a business, there are several ways to learn what its income is; the simplest being just to ask. This is often more effective than many would think. Nevertheless, this may not be an alternative for many or often the response will not be accurate.

When this is the case a spouse’s lawyer may subpoena the business records. This may include internally prepared financial statements, bank statements, and loan applications, as well as bank accounts and credit card statements, and/or accounting records. These financial documents contain a wealth of information and a skilled CPA can help examine the documents to establish what is the real economic income. For example, since small owner-controlled businesses will often pay personal expenses, even in a business with substantial revenues may still show little profit. While the expenses paid by the business are not a direct form of compensation, the practice can be very beneficial to the owner. These are often referred to as ‘perquisites’ and are added back when determining the true profitability of a business. Often detailed accounting records are required to identify and support these add-backs

One should also obtain a personal or business tax return depending on how the business is structured. Obtaining the actual return filed with the IRS is a good place to start. In order to get a copy of the return, IRS form 4506 can be submitted to request a copy of the return filed with the IRS. This way, one can verify that disclosure is providing the real numbers and not a “second set of books.”

Business valuation is a very complex process and will usually require an expert. Be sure to hire a business appraiser who holds a recognized business valuation credential, such as an ASA, ABV, or CVA, and one who practices business valuation full-time. You may also need a CPA to help with the income reconstruction. Here at Advent Valuation Advisors, all professionals hold either a CPA license and an ABV business valuation designation or have an ASA credential (Accredited Senior Appraiser) in business valuation, an internationally recognized business valuation credential awarded to highly experienced appraisers by the American Society of Appraisers.

So You Want To Sell Your Business

We have recently had an influx of clients coming to us and stating they are thinking about selling their business and need help figuring out at what price it should be sold.  For many small business owners, selling a business represents the culmination of their entrepreneurial career. Most owners have worked very hard to build the business and make it what it is today but are thinking it may be time to slow down and enjoy the fruits of their labor.

However, many business owners are surprised at the stress involved in selling their business. We suggest that the best way to minimize the stress is to prepare and begin to work through it step by step.

  1. Assess your reasons for selling. This is also the time to ask yourself what you hope to achieve in the sale, i.e. what is the amount you want to receive for your company.
  2. Seek out advice and help to develop your strategy from your trusted advisor. Consult with a team of professionals.  Advent can handle the valuation.  A commercial realtor or business broker can be a real help in terms of finding and dealing with prospective buyers or your company and helping you navigate the sales process.  An attorney is also necessary to draw up and review documents necessary to sell the company.
  3. Determine what your business is actually worth.  Here is where Advent can help.  Determining your business’ value can be a complex process. You will want to identify a fair and objective price for your company that will attract buyers and doing so will require the application of one or more generally accepted methods of business valuation. Understanding not only the what of a reasonable value but the way of a reasonable value often helps owners to put aside the emotional connection to the business that can lead to an inflated value for the company.  Having a valuation performed may also reveal operational deficiencies that can reduce the value of the business or make the business difficult to attract offers.
  4. Get your business ready for sale (put the house in order).  When you sell a house, there are usually things that need to be done to prepare it for sale and make it presentable to potential buyers. The same is true when you sell your business. Here is the chance to implement any of the operating deficiencies identified during the valuation.  Potential buyers will want to examine assets such as buildings and equipment firsthand; but they’ll be even more interested in your business’ financial statements so you need to keep your business records up to date.  With the help from Advent, you can also prepare a packet of financial information that reflects the financial condition of your business, presented in such a way that supports the asking price.
  5. Screen potential buyers.  Not everyone who expresses interest in your business will be a serious buyer. Some people shop for businesses like women window shop for shoes. The problem is that showing your business to potential buyers takes time. Rather than waste time with insincere prospects, it is much better to screen buyers in advance and only meet with those who are truly serious.  Business owners shouldn’t provide any information about the business until they have determined the potential buyer is capable of completing the transaction. It is not unheard of for competitors to disguise themselves as buyers in order to gain information about the competition.
  6. Finalize the sale.  Once a deal has been negotiated it is up to the attorneys and lenders to finalize the sale. All you have left to do is sign a few papers and ride off into the sunset.

Selling your company is serious business, so you want to make sure you take the time and trouble to do it right. Careful preparation and using the professionals, such as Advent, are the keys to the success.  Call us.

To Restructure or Liquidate

When a business finds itself on the road to serious financial trouble and unable to obtain financing from new or existing sources of capital, or solve its financial problems quick enough internally, it should pursue a solution through its creditor constituencies. This can be done either out of court or with the assistance of the federal bankruptcy code. Under either of these approaches, the debtor has many alternatives in seeking relief. The appropriate approach will be influenced by a number of variables, including the debtor’s size, financial history, capital structure, nature of the problems and the outlook for the business.  In examining the options two major issues must be addressed; should the business restructure or liquidate and should the reorganization or liquidation take place out of court or in bankruptcy court?

In choosing the best alternative it is imperative to understand what caused the debtors current troubles, whether the company will be able to overcome them and, if so, what actions will be required to turn the company around. Advent Valuation, as financial advisor, canassist the Company, or its creditors, in determining how the losses occurred and what can be done to evade them in the future.

To aid in this determination, it may be necessary to forecast the cash flow of the operations for weekly periods for a term of thirteen weeks. This is one of the most powerful cash management tools. The 13-week cash flow projection is utilized by management of distressed companies to help manage and anticipate short-term liquidity needs. Advent can also be helpful in indicating where additional steps will be necessary in order to obtain positive cash flow. The best indication that a failing business has a reasonable chance for a recovery is the presence of three attributes.

  1. A core business capable of generating cash flow, preferably showing a positive EBITDA and the ability to meet future challenges
  2. A new source of funding, preferably long term
  3. A management team capable of assuming operating control of the firm

For existing clients, the information needed to choose the course of action can be accomplished with minimal additional work.  However for a new client, a review of the client’s operations will be required to ascertain the company’s situation. Once the analysis has been completed, and unless additional capital is raised or a buyer for the company is found with assistance from its advisors, the client normally makes the decision to:

  • liquidate the business
  • attempt an informal settlement with creditors, or
  • file a chapter 11 petition.

For example where a company’s product is inferior, with declining demand, inadequate distribution channels, or other problems exist that cannot be corrected (either because of economic reasons or management’s lack of ability), it is normally best to liquidate the business immediately.  Postponing a closeout strategy greatly diminishes the liquidation value if customers abandon the company and business relationships deteriorate.

Conversely, if the company is determined to be viable the decision whether it should immediately file a chapter 11 petition or attempt an out of court settlement depends on several factors including:

  1. Size of the company and whether it is public or private
  2. Number of creditors and if they are secured or unsecured
  3. Complexity of the situation
  4. Nature of the debt, prior relationships with creditor constituencies, and pending lawsuits
  5. Executory contracts, including leases
  6. Tax implications of alternative selected
  7. Capabilities of management, including mismanagement, fraud and irregularities.

In summary, hiring both Advent and a component bankruptcy attorney can help a company work through the question of whether to restructure or liquidate.  Advent Valuations Advisors is here to work through the difficult questions with you.