Articles By Michael Levensohn

Are Your Company’s COVID-19 Losses Covered?

Business interruption insurance may provide some relief to owners forced to close their businesses because of the COVID-19 pandemic. Photo by Alexander Kovacs on Unsplash

The restrictions put in place to stop the spread of COVID-19 – such as limiting crowd size, closing restaurants and bars and canceling sporting events – are critically stressing many businesses.

One possible form of relief to this financial crisis is insurance coverage, including business interruption and contingent business interruption coverage. Business interruption insurance (also known as business income insurance) is a type of insurance that covers the loss of income that a business suffers after a disaster.

The loss of income covered may be due to disaster-related closing of the business facility or the rebuilding process after a disaster. Coverage may include lost revenues, rent or utilities, among other things. A contingent business interruption provision generally provides coverage for a loss of income related to a problem experienced by a supplier or vendor.

However, there are likely some hurdles to obtaining coverage based upon disruption from COVID-19. For example, a typical business interruption provision reads:

“We will pay for the actual loss of business income you sustain due to the necessary suspension of your ‘operations’ during the period of ‘restoration.’ The suspension must be caused by the direct physical loss, damage, or destruction to property. The loss or damage must be caused by or result from a covered cause of loss.” 

A “direct physical loss” has been held to exclude economic losses unaccompanied by a distinct and demonstrable loss of the physical use of the business property. Furthermore, after the SARS epidemic in the early 2000s, insurance companies began to exclude viral outbreaks from typical coverage, though exclusions for losses in connection with viruses may not be ironclad.

Coverage depends on the particular policy, and a policy review may prove useful. Not all insurance policies are identical in the coverage they provide.

You will likely find that more expensive policies often provide better coverage than lower-cost policies. Also, coverage for COVID-19 related losses might be contingent on whether the policy provides business interruption coverage as a basic term of the policy or as an endorsement. An endorsement will often provide broader coverage than the base policy because of the additional premium for the endorsement.

Insurance companies will certainly oppose paying business interruption losses in connection with COVID-19, though with advice from your insurance broker and/or attorney, filing a claim may be a good first step. In addition to filing the claim, Advent believes business owners ought to:

  • Analyze your policy and review the law. Don’t be afraid to consult your company attorney if you have questions. For example, if the policy does not adequately define “physical damage” (which can be required to recover business interruption losses) and that term presents ambiguity in the specific context of your company’s loss, you may be covered. 
  • Make note of virus exclusions. One can imagine this law is undeveloped and there is not clear precedent on coverage. Also, some policies may contain civil authority provisions, which could offer coverage for losses suffered in connection with government-ordered shutdowns.
  • Stay informed regarding legislative developments and any other pertinent changes. Finding every possible basis for recovery under your business’s policy will only enhance any potential recovery.

To learn more about the quantification of lost profits, please contact one of the experienced professionals here at Advent.

The Difference Between Price and Value

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When a business is sold, it often sells for more (or less) than the appraised value. This may come as a surprise to laypeople, but valuators understand that there are many valid reasons that “price” and “value” may differ. Businesses that understand this subtlety are better positioned to make informed decisions.

Price is specific to an individual buyer and seller. It’s the amount of cash (or its equivalent) for which anything is bought, sold or offered for sale. It requires an offer to sell, an acceptance of that offer and an exchange of money (or other property). Some strategic or financial buyers may be willing to pay more than others because they can benefit from economies of scale or synergies that aren’t available to all potential buyers.

The term “value” often refers to “fair market value” in a business valuation context. The International Glossary of Business Valuation Terms defines fair market value as:

The price, expressed in terms of cash equivalents, at which property would change hands between a hypothetical willing and able buyer and a hypothetical willing and able seller, acting at arms-length in an open and unrestricted market, when neither is under compulsion to buy or sell and when both have reasonable knowledge of the relevant facts.

Fair market value is essentially a consensus of what the universe of potential buyers would agree to pay for a business, a business interest or an asset. In the real world, sales may occur for more (or less) than fair market value, because the individual parties have their own perceptions of the investment’s risk and return, are under duress to buy (or sell), or lack relevant knowledge about the transaction or the subject company.

Another reason that value and price frequently differ is timing. In many cases, a valuator’s work is done months or years before the company is sold. Differences in market conditions or the company’s financial performance between the two dates could cause the company’s selling price to vary from its appraised value.

Real World Example

To illustrate how price and value may differ, consider the sale of a medical practice. There are primarily three potential buying groups for medical practices:

  • Another physician,
  • A physician group, or
  • A hospital.

To determine fair market value, a valuator would consider potential transactions to purchase the practice by all three of these groups, under the cost, market and income approaches. But in the real world, only one specific buyer would make an offer. So, for example, the analyses involving a physician or physician group wouldn’t be relevant if a hospital is buying the practice.

Price and Value Aren’t Synonymous

It’s critical for buyers and sellers to understand that the appraised value of a business interest may not reflect its future selling price. Value can vary substantially, depending on the effective date and the purpose(s) specified in the appraiser’s report.

When the purpose of a valuation is to establish an asking (or offer) price, valuators may provide a range of values that considers various buyers and transaction scenarios. This range can help a buyer and seller arrive at a reasonable selling price that’s based on the individual parties’ expectations of risk and return.

If you’re planning to buy or sell a business interest, the professionals at Advent Valuation Advisors are here to help.

© 2020, Powered by Thomson Reuters Checkpoint

Lost Profit Claims Face High Hurdles in NY

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Lost profits claims are difficult to prove under New York law. This is particularly true for a new business, or an existing business entering a new market or line of business.

A recent decision in a case heard in Arizona District Court – but involving a supply agreement governed by New York law – provides some insight into the hurdles faced by such claims.

In IceMOS Technology Corporation v. Omron Corporation (2:17-cv-02575) , the plaintiff, a business that sells semiconductor components, sued the defendant alleging breach of the supply agreement. The plaintiff’s claims included lost profits. The defendant countersued, and the case is ongoing.

In November, the court granted the defendant’s motion to dismiss the lost profits claim, finding that the plaintiff did not establish lost profit damages with reasonable certainty.

Three-Part Test

As explained in the decision, under New York law, there are two broad categories of damages that can result from a breach of contract. The first is the general damages that are the natural and probable consequence of the breach. The second is special or extraordinary damages that do not flow directly from the breach. A claim for lost profits is an example of a claim for special or extraordinary damages. New York uses a three-part test to determine if a party is entitled to recover lost profits:

  1. The damages must be caused by the breach of contract. 
  2. The loss must be proven with reasonable certainty. 
  3. The party making the claim must demonstrate that the lost profits were foreseeable, that they were in “the contemplation of the parties at the time the contract was made.”

For a new business, the bar is set even higher. In order to establish reasonable certainty, a new business making a lost-profits claim must generally support the claim “with evidence of a history of profit or comparison of the new business with other comparable and profitable businesses.”

In addition, a new company must consider general market risks that might hurt its future profits, such as new competitors, technological or regulatory changes, or general market movements.

The hurdles for new businesses also apply to existing businesses entering new markets. This was the case for IceMOS, which reached an agreement with Omron Corporation in 2011 under which Omron would fabricate semiconductor wafers for IceMOS over several years. IceMOS purchased just a small fraction of the agreed-upon quantity. The court found that the plaintiff was a new business, as IceMOS was entering a new market, and held it to the higher standard.

The plaintiff’s lost profits claim relied on projections by the company’s president and a pair of experts. The plaintiff did not show a history of profits or any comparisons with profits of similar businesses. The court noted that, in New York, projections are generally not sufficient to establish lost profits with reasonable certainty. “Without a history of profit or evidence showing the profitability of other like-businesses, Plaintiff cannot establish lost profit damages with the reasonable certainty New York law requires for new businesses.”

The decision builds upon a series of earlier rulings that address aspects of the three-part test and the heightened evidentiary burden for new businesses. You can read the decision here.

Please contact us if you have questions about the determination of lost profits or the calculation of other types of damages.

Considering a Business Acquisition?

You wouldn’t perform a surgery on yourself. The same holds true when buying a business. Unless you’re well-versed in performing a comprehensive financial analysis of a business, it doesn’t make sense to buy one without using a due diligence and valuation specialist. A due diligence report:

  • Verifies the accuracy of the seller’s information.
  • Outlines a detailed understanding of the business.
  • Contains vital information that can be used for negotiating the transaction, obtaining financing, establishing the tax and accounting basis of the assets, and integrating the acquired entity into the buyer’s business.

Most of all, due diligence identifies possible deal-breakers. A seller may “prepare” a business for sale, making it look better than it really is, in order to obtain a higher price. A professional due diligence review guards against the overstatement of assets and understatement of liabilities. It also provides an analysis of historic earnings and the likelihood that forecasted operations can be met.

One crucial, but often overlooked, part of due diligence involves the tax consequences of the proposed transaction. Depending on the operating structure of the acquiring company and the target (for example, a C corporation, S corporation or partnership), it may be better to receive assets versus stock. Keep in mind that a badly structured sale can result in a tax disaster.

Contact Advent Valuation Advisors to learn how due diligence can keep a sale from resulting in costly errors.

© 2020, Powered by Thomson Reuters Checkpoint

Understanding the Terms of Engagement

When you need to know how much your business is worth, one of the first questions to ask is, how much work – and how much expense – will it take to get the job done?

In many circumstances, a comprehensive valuation is required or preferred. Sometimes, however, a relatively straightforward, and less costly, calculation of value may be sufficient. The purpose of the valuation will often dictate the scope of work that is appropriate.

Both the American Society of Appraisers (ASA) and the American Institute of Certified Public Accountants (AICPA) have defined the scope of various assignments used to value a business, business ownership interest, security or intangible asset. In its Business Valuation Standards, The American Society of Appraisers (ASA) defines three types of engagements:

  • An appraisal engagement is the most comprehensive. It considers all relevant information as of the appraisal date and results in the expression of an unambiguous opinion of value, which is supported by all procedures the appraiser deems relevant.
  • A limited appraisal engagement is based on consideration of limited relevant information and limited procedures deemed necessary by the appraiser. It results in an estimate of value.
  • In a calculation engagement, the appraiser and the client may agree on the procedure or procedures to be performed. The appraiser collects limited information, performs limited procedures and provides an approximate indication of value.

The American Institute of Certified Public Accountants defines two types of engagements:

  • In a valuation engagement, the valuation analyst applies the approaches he or she deems appropriate. The result is a conclusion of value.
  • In a calculation engagement, the analyst and the client agree ahead of time on the procedures the analyst will perform, and these procedures are generally more limited than in a valuation engagement. The result is a calculation of value.

A full appraisal or valuation engagement will generally result in the production of a comprehensive report that describes in detail the procedures performed, while a calculation may result in an estimate, with limited additional information provided to the client. In any of the engagements described above, the resulting value may be a single amount or a range.

So, how does a business owner determine which type of engagement is appropriate?

The right tool for the job

There are times when a calculation may be sufficient. For instance, a small business owner who receives an offer to sell his or her business may simply want to gauge the fairness of that offer. According to the AICPA’s Statements on Standards, a calculation engagement also may be acceptable when acting as a neutral party in a dispute. For a matter involving the IRS or the Tax Court, a full valuation resulting in an opinion/conclusion of value is generally preferred.

The use of calculations in court matters has become a contentious matter. In a piece in the November 2019 issue of Business Valuation Update, Michael Paschall, an accredited senior appraiser and attorney, criticizes a phenomenon he terms “calculation creep,” the increased use of calculation engagements in litigation settings.

He claims the “incomplete and potentially biased aspects of calculation engagements represent a dumbing down of the valuation process and profession,” and calls on the governing bodies in business valuation to bar calculations for litigation, ESOPs, IRS purposes “or any other context where a reliable opinion of value is needed or third-party reliance is present.”

In Hanley v. Hanley, a case decided in June 2019 in New York State Supreme Court in Albany, the court rejected a value calculation produced by an accountant retained by one of the parties. The decision cites several concerns, including questions about the independence of the valuation professional and the lack of documentation in the valuation report, which did not describe the limited procedures or approaches used in the calculation.

At the end of the day, any valuation is only as credible as the professional who renders it. The judgment of the valuation professional is a key ingredient in every phase of the assignment, from determining the appropriate scope to selecting the best methods, reconciling the results of different procedures and, ultimately, deriving the indicated value.

Advent’s valuation professionals can walk you through the process and help you determine what type of engagement will best meet your goals.

Recession, Election Fears Weigh on Values

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Business brokers say fear of a recession and uncertainty over the upcoming presidential election may be driving down business valuations, according to the third-quarter edition of Market Pulse, the quarterly survey of business brokers conducted by the International Business Brokers Association and M&A Source.

Fifty-three percent of business brokers surveyed cited the prospect of a recession as the biggest concern affecting U.S. business valuations, followed by the presidential election and the trade war with China.

“Small business owners are worried that a recession is coming, and trade issues are causing volatility. All that nervous energy means buyers are dialing back a bit – particularly on the smaller market deals.” said Craig Everett, PhD. Everett is director of the Pepperdine Capital Markets Project at the Pepperdine Graziado Business School, which compiled the survey results.

The national survey is intended to capture market conditions for businesses sold for less than $50 million. It divides that market into three classes of main street businesses with values of $2 million or less, and two lower middle-market ones in the $2 million to $50 million range.

The survey found that businesses selling for $5 million to $50 million garnered a 9 percent premium over asking price during the third quarter, while the smallest main street businesses, those worth less than $500,000, sold for just 85 percent of asking price, the lowest percentage in four years.

Scott Bushkie, managing partner of Cornerstone Business Services, told Market Pulse that falling business confidence has slowed the activity of the individual buyers who account for most main street business acquisitions.

“Confidence always gets shaky as we enter an election season,” said Bushkie, whose firm has an office in Iowa, where the first caucus of the 2020 presidential campaign will be held February 3. “There’s this general escalation of reports pointing out economic weaknesses and policy flaws, and people sometimes internalize that negativity. I think we may be feeling that even earlier than normal this time around.”

Seller financing

Market Pulse found that sellers provided roughly 10 percent of the buyer’s financing in deals that closed during the third quarter. Earn-outs and retained equity were less common.

“Lenders always like to see sellers keep some skin in the game,” said Justin Sandridge of Murphy Business Sales-Baltimore East. “When sellers aren’t willing to finance any of the purchase price, that sends warning signals to buyers and lenders alike. Refusing to provide seller financing is like holding up a giant ‘no confidence’ sign, and it’s likely to scare other parties away from the deal.”

Market Pulse’s third-quarter survey of 236 business brokers and M&A advisors was conducted from October 1-15. The respondents reported completing 210 transactions during the third quarter.

Price Multiples Decline During Third Quarter

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Small business sales during the third quarter of 2019 yielded EBITDA multiples about 26 percent lower than a year before, according to the latest edition of DealStats Value Index. It’s one of several developments noted in the report that point to an emerging buyer’s market.

The median EBITDA multiple – the ratio of selling price to earnings before interest, taxes, depreciation and amortization – slid to 3.7 for transactions completed in the third quarter, down from 4.0 during the preceding quarter and the peak of 5.0 reached during the third quarter of 2018. The EBITDA multiple during the third-quarter of 2018 was the highest quarterly mark since at least 2013.

DealStats is a database of private-company transactions maintained by Business Valuation Resources. The database is used by business appraisers when applying the market approach to valuation. Multiples such as sale price-to-EBITDA can be derived from transactions involving similar businesses and used to estimate the value of a company, subject to adjustments for unique characteristics of the business being valued.

Over the longer term, DealStats notes that EBITDA multiples have generally trended downward since 2017, falling to a six-year low in 2019.

It’s important to bear in mind that DealStats data only reflects transactions reported to the service, and the data is subject to revision as additional sales are reported. For instance, the median EBITDA multiple for the April-June quarter was initially reported as 4.2. That was revised to 4.0 in the latest report. The spike to 5.0 during the third quarter of 2018 was previously reported as 4.4 and 4.5.

The delays in reporting may limit the value of information regarding trends gleaned from the quarter-to-quarter gyrations of multiples.

EBITDA margins decline

Businesses sold in 2019 have tended to be less profitable than those sold in recent years, according to the DealStats data. The median EBITDA margin (measured as a percentage of revenue) was just below 11 percent during the third quarter, up slightly from the second quarter, but down from 12 percent in the first three months of the year. EBITDA margins have generally trended lower since 2013.

A long time to sell

Businesses are taking longer to sell, according to DealStats. The median number of days for private businesses to sell was 221 for deals closed during the first half of 2019. That marked the fifth straight half-year period (dating back to the first half of 2017) where the median exceeded 200. From 2013 to 2016, the median never topped 200 days.

Revenue multiple falls

DealStats reports that the median sale price-to-revenue multiple this year is 0.45, down from 0.49 in 2018 and the lowest multiple in at least a decade. Businesses in the finance/insurance sector garnered the highest multiple, at 1.75, followed by information at 1.70 and professional, scientific and technical services at 0.89.

The highest EBITDA multiple was noted in the information sector, at 11.1, followed by mining, quarrying and oil and gas extraction, at 8.5. The lowest multiple was 2.6 for the accommodation and food service industry.

Business valuation professionals use transactions such as those collected by DealStats to derive a business’s market value. If you have questions about how comparable sales influence the value of your business, or how much your business is worth, please contact us.

Buy-Sell Agreements: What You Should Know

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For many of our clients, their investment in their business is the most significant financial asset they own. Many are baby boomers (individuals born between 1946 and 1964) who have reached or are approaching the transition from working to retirement. As that transition occurs, their small or medium-sized businesses will be sold or otherwise passed on to the next generation of owners.

It is often during these times of transition that the importance of buy-sell agreements becomes evident. Buy-sell agreements spell out the terms for transferring an interest in a business upon the death or departure of an owner. The time to create such an agreement is not during a transition, but rather at the start, when all of the owners are involved and an orderly transition can be planned. In our role as appraisers, we have seen many clients who either don’t have a buy-sell agreement or whose agreement simply doesn’t work as the shareholders expected.

As a shareholder, ask yourself three questions:

  1. Do you have a buy-sell agreement?
  2. Do you know what your buy-sell agreement says?
  3. How is your buy-sell agreement funded?

Even in companies that have agreements in place, we often find that they are not current, have a price determination that isn’t fair or workable for all parties, or lack funding arrangements for events that trigger a transfer. These situations can result in protracted litigation or even the demise of the business. If you have a buy-sell agreement, it may be time to review it.
The four most common ways that business owners exit their privately held businesses are a sale to a third-party, gifting ownership interests to family members, selling to employees and liquidating. Buy-sell agreements can provide guidance in all of these situations. Read your agreement to see if the language delivers the results you desire in each situation. 

A review of your agreement should focus on three key areas: triggering events, pricing and funding.

Triggering Events

The agreement should define the transfer process for triggering events such as shareholder retirement, termination of employment, death, disability, sale, divorce and bankruptcy.

Pricing

Transaction prices in buy-sell agreements are usually defined by a fixed price, a pricing formula or an appraisal.

Fixed prices are easy to understand and easy to set initially, but may be difficult to reset as time passes and interests diverge. The provisions are rarely updated, and inequities are likely to result.

Formula-based pricing provides a mechanism to update the value based on various metrics in the business. However, a formula selected at a point in time rarely provide reasonable and realistic valuations over time. Changes in companies, industries and the local and global economies may impact the true value of an enterprise relative to any set formula. And formulas may be subject to multiple interpretations.

If appraisals are used, all parties will understand the valuation process from the start, and they’ll know what to expect when a triggering event occurs. Appraisers can incorporate key business drivers and risks into the determined value. Periodic appraisals provide a mechanism for keeping a buy-sell agreement up to date, so that all parties know the current value of the business and their interests. An updated valuation provides valuable information for business and personal financial planning, as well.

We recommend clients consider appraisals of their businesses. Though this comes at an additional expense, owners should make the small investment to understand what their business is worth with an annual or periodic valuation. They will potentially save much more in litigation or exit costs later.

Funding

The buy-sell agreement should spell out how transactions will be funded in situations where the company buys shares back from shareholders. Management’s plan should spell out several key points:

  • Who will buy the shares? Other shareholders, the company or a combination?
  • Should the company hold life insurance to fund share purchases if an owner dies?
  • What are the terms of the transaction (down payment, interest rate, security)?
  • Are there any restrictions on share payments under the company’s loan agreements?

We have seen a variety of other deficiencies in buy-sell agreements. Some lack the signatures of current shareholders. Others have not been updated for several years. In others, the level of value is not identified.

As you can see, there are a number of issues which, if handled poorly, could result in your buy-sell agreement creating as many problems as it solves. Used properly, the buy-sell agreement is a great tool to provide guidance for all kinds of triggering events that affect shareholders. We encourage you to discuss these matters with shareholders and your attorney. If you are in need of a current appraisal, please call us.  

WeWork Mess Highlights Perils of Investing in Unicorns

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WeWork has accepted a bailout by its largest investor, SoftBank Group, which will take an 80 percent ownership stake in the company, according to multiple media reports. The rescue package reportedly values the company at about $8 billion, a stunning reversal from its $47 billion valuation in January, based on SoftBank’s infusion of $6 billion at the time.

From a valuation perspective, the rapid deflation of WeWork’s bubble speaks to the hazards of investing in unproven young companies. This year has seen a string of high-profile initial public offerings by companies that don’t make money (most notably Uber and Lyft) and face stern questions about their paths to profitability. Uber in particular has been growing revenue at the expense of profit, while creating unrealistic customer expectations about the actual cost of transportation – or of having a hamburger and fries delivered to your home.

WeWork was built on a similar model, although its results have been even more extreme. The company, which leases office buildings, spends millions sprucing them up, then subdivides them and seeks to fill them with member/lessees, loses more than $5,000 per customer, according to its public filings. The company lost $690 million during the first half of 2019 on $1.5 billion in revenue. Last year, it lost $1.6 billion on revenue of $1.8 billion.

In January, it was valued at $47 billion, or 26 times its 2018 revenue, based on the SoftBank investment. That multiple, it turns out, was too rich for investors. The company’s IPO filing in August inspired a wave of intense scrutiny and criticism, culminating in the withdrawal of the IPO on September 30.

The failed IPO is a reminder that investing in young, money-losing companies marries the prospect of lofty rewards with a high failure rate. As MarketWatch columnist Brett Arends pointed out in his excellent recent piece on Uber, the experts frequently make mistakes in valuing “revolutionary” companies. He notes that powerhouses like Amazon, Facebook and Netflix all faced questions early on about untested management, potential strategic missteps and supposedly rich valuations.

Unlike those companies, WeWork has yet to articulate how it might ever achieve profitability. An early hint regarding the company’s fate came in 2017, when founder and then-CEO Adam Neumann told Forbes, “Our valuation and size today are much more based on our energy and spirituality than it is on a multiple of revenue.”

While it’s important to do your homework before making any investment, betting on an unprofitable young company requires a leap of faith. Unlike Neumann, who will reportedly receive more than a billion dollars to walk away, the rest of us don’t get parachutes.

Court Addresses Stock Compensation in Divorce

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Divorce is almost always complicated, especially when there is a lot at stake. In today’s article, we will explore the handling of stock compensation in divorce proceedings.

Compensation for executives in medium and large corporations often goes beyond standard payroll and perquisites (the special rights that come with the position). It can also include forms of payment to reward the executive for prior performance or to encourage strong future performance. This compensation can take the form of stock options or restricted stock units (RSUs).

In New York (an equitable distribution state for purposes of dividing marital assets) stock options and RSUs acquired during the marriage are presumed to be marital property, unless the holder can prove they were acquired as a gift or inheritance or in exchange for other non-marital property. One can determine if the options were granted as a reward for past services by examining the plan documents, such as the Stock Options Plan and the Options Statement. These documents should address exercise price, expiration date and other terms, including some that may pertain to divorce.

If the stock is publicly traded, its value is based on the fair market value of the stock – the amount at which a share of stock is being traded – usually at the date of trial or the date of the legal action. Valuation of the stock of a privately held company is more problematic, and will necessitate a business valuation. When performing the business valuation, the appraiser examines a host of factors, including the type of business, prior sales of company stock, the future outlook for the company and goodwill.

The non-propertied spouse must be watchful for deception, particularly in smaller companies, where the executive can negotiate, sometimes orchestrate, their compensation package. In other words, were the stock options granted as a reward in addition to normal compensation? Or is the executive receiving the options in lieu of a raise?

The New Jersey Appellate Court recently decided a case regarding how RSU compensation should be evaluated and divided in a divorce. In M.G. v. S.M., the plaintiff’s employer had issued RSUs to the plaintiff over the course of an eight-year period. These RSUs were subject to a vesting schedule established by the employer. After a stated period of time, vesting would occur and the employee would take ownership of the stock.

Although eight years’ worth of RSUs had been granted to the plaintiff, at the time of the filing of the divorce complaint, only three years of the grants were vested. At trial, the judge heard testimony from the plaintiff about the stock units, including the plaintiff’s agreement that the defendant was entitled to share in the value of the vested units.

However, the plaintiff argued that the non-vested RSUs were not distributable to the defendant. The plaintiff submitted evidence that his company issued the RSUs to employees to incentivize future performance and encourage them to remain with the company so that their interests in the RSUs would vest. The trial court’s opinion was that all of the RSUs were “the result of prefiling, marital efforts, and are thus subject to equitable distribution,” regardless of when they vest.

There is a lack of significant guidance in the form of case law with respect to how RSUs are divided in divorce in many states. The Appellate Court explored the possible methods by which to value and divide the assets. The court ultimately deciding to rely on guidance from a Massachusetts case that dealt with the same subject. The New Jersey Appellate Court held that the following is the appropriate analysis to consider when dividing RSUs in a divorce:

  1. Where a stock award has been made during the marriage and vests prior to the date of complaint, it is subject to equitable distribution.
  2. Where an award is made during the marriage for work performed during the marriage, but becomes vested after the date of the complaint, it, too, is subject to equitable distribution.
  3. Where the award is made during the marriage, but vests following the date of complaint, there is a rebuttable presumption that the award is subject to equitable distribution, unless there is a material dispute of fact regarding whether some or all of the award was consideration for future performance.

The Appellate Court went on to state that the party who wants to exclude the assets – i.e. the party to whom the RSUs were granted – must demonstrate that they were issued for work performance after the filing of the complaint for divorce.

Based on the Appellate Court’s decision, it is likely that the plaintiff in M.G. v. S.M. will be successful in excluding at least a portion of the unvested RSUs from equitable distribution of the marital estate, as his trial testimony stated that his employer’s intent in issuing RSUs was to encourage positive future performance.

Therefore, the purpose for which the executive compensation is issued by the employer may also impact the division of those assets in divorce. If you have questions about how your executive compensation package may be valued, contact Advent Valuation Advisors today.

The case is Superior Court of New Jersey Appellate Division Docket No. A-1290-17t1, December 26, 2018. The decision is available here:

https://adventvalue.com/wp-content/uploads/2019/10/MG-vs-SM.pdf