Source: https://www.walzermelcher.com/practice-areas/measuring-the-valuation-of-a-law-firm-in-divorce-proceedings/
Timestamp: 2019-04-18 17:21:17+00:00

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The value of an attorney’s goodwill – whether “true,” “fair market,” or some other standard is difficult to determine, but at least a commonsense test exists for fair market value.
Ever since the sale of law practices became legal in California in 1989, pricing information about law practices has been accumulating.
In 1974 in Foster5 which involved the valuation of a medical practice, the appellate court allowed the trial courts wide discretion to accept any legitimate method of valuation of a professional practice. The court said that any method of valuation “that measures its present value by taking into account some past result” is legitimate.
The appraiser who testified in Foster determined the value of the medical practice by taking three months of the doctor’s gross income. According to Foster, the expert argued that “there is no definite method by which the value of goodwill can be determined and that it is ‘always just somebody’s opinion.’”6 The Foster appraiser made it clear that he did not contend that the value of $27,000 that he assigned to the goodwill of the practice was what the seller would get if the practice were put on the market for sale. He did say that a hypothetical buyer would pay some price for goodwill, but he had no opinion about what that price would be.
The appellate court approved of the appraiser’s methodology, declaring that a court is not restricted to market value and need not find evidence of “what a willing buyer would pay for the community goodwill.” The Foster court indicated that the standard of value was not the fair market value but did not replace fair market value with another standard.
An article in the Journal of the American Academy of Matrimonial Lawyers criticizes the excess earnings approach for being not only speculative but also “simply a method of valuing future earnings. Future earnings are not marital property.’ [This method] may produce unrealistic figures which overvalue the goodwill, when the professional spouse is required to pay tangible assets in exchange for intangible goodwill value.”21 Furthermore, Revenue Ruling 59-60 states, “The [excess earnings] approach should not be used if there is better evidence available from which the value of intangibles can be determined.”22 The excess earnings approach can impose hardship on attorneys who suffer economic loss after they have paid their spouses for the value of their practices. Whether the loss is caused by a change in the law, loss of a major client, loss of key personnel, an economic downturn, personal disability, or even death, attorneys will have paid for an asset that is no longer worth what they paid for it. For example, spouses of successful medical malpractice attorneys whose practices were valued in divorce prior to the enactment of the Medical Injury Compensation Reform Act may have received a substantial windfall. Errors can happen no matter what method is used, but it seems that this type of error is more likely when courts rely on past earnings to predict future performance.
The idea that something that cannot be sold has value defies logic, and a finding that a business that will not be sold in a marital dissolution should have a premium place on it is preposterous.
This is not the law in California, but it should be, not only because of the speculative nature of calculating goodwill but also because evidence of the market value now exists.
One of the historic justifications for not using fair market value as the standard is that nonprofessional spouses would be economically disadvantaged by not being compensated for the value of their professional spouses’ practices. The courts assigned an intrinsic value to the professional practices, called it goodwill, and awarded the practice to the professional, offsetting it against an award to the family residence and other assets to the nonprofessional spouse. In most cases, this was a fiction used to give wives some economic security. But now there are more professional women in the workplace than ever before. There are more women attorneys, and there are more women owners of professional practices. Women’s earning power, although still lagging, is on the increase.33 Placing a high value on a law practice no longer necessarily benefits a woman in a marital dissolution.
Judges should first consider evidence of recent sales of similar practices, a bona fide offer to purchase the practice, or relevant testimony that the practice can in fact be sold at all before applying the fair market value approach or other methods of valuation. But whatever methods are used, the court should first determine if the practice can be sold. If it cannot be sold, it has no goodwill and has no value beyond the firm’s tangible assets.
It may be some time before California courts return to a fair market standard of valuation. Unmarried lawyers who are going into practice for themselves or who are already in practice should not consider getting marriage without first entering into a well drafted premarital agreement in which both sides are represented by counsel. The agreement should indicate that the legal practice is separate property and that any increase in the practice’s value will be separate property. The agreement should also specify that the practice’s accounts receivable, work in progress, capital account, and goodwill are all separate property.
Attorneys who do not have a signed premarital agreement and are in the throes of a divorce can take steps to lessen the threat of a theoretical valuation of their practices. Although hard data is limited, more practitioners are buying and selling practices. Many different professionals may be called upon to provide evidence of value. They include law firm management consultants, business opportunities brokers, accountants, valuation experts, attorneys, and marketing consultants. The Internet and classified advertisements may have leads to comparable sales. Many managements professionals have the expertise and data to support values based on sales of these practices.
* Peter M. Walzer is a Fellow of the American Academy of Matrimonial Lawyers who practices in Los Angeles and Ventura Counties, and Edward Poll is a nationally known law firm management consultant.
1In re Marriage of Foster, 42 Cal.App.3d 577, 117 Cal. Rptr 49 (1974). The Foster court defines goodwill as “the advantage…acquired by an establishment beyond the mere value of the capital stock, funds or property employed therein, in consequence of the general public patronage and encouragement which it receives from constant or habitual customers…. Goodwill is property of an intangible nature and is a thing of value.” Id. at 581-82 (citing In re Lyons, 27 Cal. App. 293, 297 (1938); see also Piedmont Publishing Co. v. Rogers 193 Cal.App 2d 171 (1961).
2Foster, 42 Cal. App 3d at 583.
3See Rev. Rul. 59-60, 1959-1 C.B. 237.
6Id. at 580 (quoting the expert).
8In re Marriage of Hewitson, 142 Cal.App. 3d 874, 191 Cal. Rptr 392 (1983).
9Id. at 888 (holding that Fam. Code § 2550, former Civ. Code § 4800(a), does not require the value of closely held shares to be determined by market value).
(e) The dividend paying capacity.
(g) Sales of stock and the size of the block of stock to be valued.
12Hewitson, 142 Cal.App. 3d at 880 (citing in re Marriage of Lotz, 120 Cal.App. 3d 379, 174 Cal. Rptr 618(1981)). See also Stephen Adams, California Family Law Practice § G.67.1 (15th ed. 2000) [hereinafter Adams]. It seems possible that although a price earnings formula of a publicly held company might be based on factors not normally present in a closely held corporation, a qualified expert might be able to identify those different considerations and adjust the public formula accordingly.
13In re Marriage of Foster, 42 Cal. App. 3d 577, 580, 117 Cal. Rptr. 49 (1974).
14In re Marriage of Sharp, 143 Cal.App. 3d 714, 192 Cal. Rptr 97 (1983).
15International Glossary, supra note 10, defines “going concern value” as “®he value of a business that is expected to continue to operate into the future. The intangible elements…result from factors such as having a trained work force, an operational plant, and the necessary licenses, systems, and procedures in place.” Going concern value equals the overall value of the business, minus net asset value, and unlike goodwill, it does not involve excess earnings.
16Sharp, 143 Cal.App. 3d at 719.
17See Adams, supra note 12, at § G.67.9. Adams argues that Hewitson “appears to be the stronger of the two cases.” On the other hand, Sharp is important because it reaffirms the standard of value as fair market value, as opposed to the vague investment value standard in Hewitson.
18In re Marriage of Foster, 42 Cal.App. 3d 577, 117 Cal. Rptr. 49 (1974).
19Mark Kohn, A Theoretical Basis for Using Three Practices, Family Law News, Spring 1995, at 5.
20Rev. Rul. 68-609, 1967-1 C.B. 576, indicates that the excess earnings approach is calculated as follows: a percentage return on the average annual value of the tangible assets used in a business is determined, using a period of years (preferably not less than five) immediately prior to the valuation date. The amount of the percentage return on tangible assets, thus determined, is deducted from the average earnings of the business for such period. The remainder, if any, is considered to be the amount of the average annual earnings from the tangible assets of the business for the period. This amount, capitalized at a percentage of 15 to 20 percent, is the value of the tangible assets of the business. But see Garrett Dailey, Attorney’s Briefcase, in California Family Law (ver. 1999.3) [hereinafter Dailey], which argues for a smaller capitalization rate.
21Helga White, Professional Goodwill: Is It a Settled Question or is There “Value” in Discussing It?, 15 J. Am. Academy of Matrimonial Lawyers 526-27 (1998) (quoting Mocnik v. Mocnik, 838 P.2d 500, 505 (Okla. 1992)).
22Rev. Rul. 59-60, 1959-1 C.B. 237.
23In re Marriage of Watts, 171 Cal.App. 3d 366, 217 Cal. Rptr 301 (1985).
24Compare In re Marriage of Webb, 94 Cal.App. 3d 335, 156 Cal. Rptr 334 (1979) (appellate court affirmed a trial court that took wife’s experts testimony that the value of the goodwill of Webb’s business was $31,468 and balanced that with Webb’s testimony that the goodwill of the business had no market value and found a value between the two of $16,000) with In re Marriage of Hargrave, 163 Cal. App. 3d 346, 209 Cal. Rptr 764 (1985) (disapproving of the Webb court’s splitting the difference).
25In re Marriage of Slivka, 183 Cal. App. 3d 159, 228 Cal. Rptr 76 (1986).
26In re Marriage of Aufmuth, 289 Cal. App. 3d 446, 152 Cal. Rptr 668 (1979), disapproved on other grounds in In re Marriage of Lucas, 27 Cal. 3d 808 (1980). Aufmuth states that a finding of no goodwill is appropriate in certain situations.
27Id. at 463. The court stated that the exclusion of goodwill in the buy-sell agreement was only one of the factors indicating that the employed spouse had not amassed any goodwill. See also In re Marriage of Nichols, 27 Cal. App 4th 661, 33 Cal. Rptr 2d 13 (1994). But note criticism of buy-sell agreements in In re Marriage of Fortier, 34 Cal. App. 3d 384, 388, 109 Cal. Rptr 915 (1973).
28See Dailey, supra note 20 (quoting Rev. Rul 59-609, 1967.1 C.B. 576).
29Marriage of Winn, 98 Cal. App. 3d 363, 367, 159 Cal. Rptr 554 (1979) (quoting Kennedy & Thomas, Putting a Value on Education and Professional Goodwill, 2 Family Law Advocate 3, 4 (1979) with approval). In consideration of goodwill, the court put a value on a horse slaughtering business with no sales value. The court in Haldeman v. Haldeman, 202 Cal. App 2d 498 (1962), found this concept valid in valuing a pharmacist’s business.
30Hanson v. Hanson, 738 S.W. 428, 435 (Mo. 1987). Texas, Florida, Illinois, and Pennsylvania adhere strictly to the standard of fair market value.
31More than two dozen states allow the sale of law practices, and information on the market value of law practices is accumulating. See, e.g., Edward Poll, Tool Kit for Buying or Selling a Law Practice (1998).
32In re Marriage of Hewitson, 142 Cal. App. 3d 874, 191 Cal. Rptr 392 (1983) (price paid in merger may not be competent evidence because the pressures are different from those in the open market).
33Statistical Abstract of the United States (1989), tables nos. 323 and 672.
34In re Marriage of Fortier, 34 Cal.App.3d 384, 388, 109 Cal. Rptr 915 (1973).
35See In re Marriage of Rosan, 24 Cal.App.3d 885, 101 Cal. Rptr 295 (1972); In re Marriage of Aufmuth, 289 Cal. App. 3d 446, 152 Cal. Rptr 668 (1979), disapproved on other grounds in Marriage of Lucas, 27 Cal. 3d 808, 815, 166 Cal. Rptr 853 (1980); In re Marriage of Micalizio, 199 Cal.App. 3d 622, 245 Cal. Rptr 673 (1988) (buy-sell when interest was a minority interest). But see Marriage of Slater, 100 Cal. App. 3d 241, 160 Cal. Rptr 686 (1979) (the buy-sell was not binding, because it was not signed for the purpose of dissolution) and Marriage of Fenton, 134 Cal. App 3d 451, 184 Cal. Rptr. 597 (1982).
36The practitioner cannot rely on In re Marriage of Aufmuth, 289 Cal. App. 3d 446, which considered the stock purchase agreement as one factor in finding there was no goodwill in new partner’s interest.
37In re Marriage of Foster, 42 Cal.App. 3d 577, 117 Cal. Rptr. 49 (1974). Judges are more likely to be receptive to this argument if evidence of market value is presented to the court. Los Angeles Superior Court Judge Richard E. Denner wrote, “If the goodwill cannot legally be transferred, it should not be valued. What should be valued is goodwill at market price. Formulas that are not used in actual sales are inappropriate.” Richard E. Denner, Goodwill, Valuation and Economic Reality, Cal. Family L. Monthly, Nov. 1988, at 144. There is a long line of cases that hold that the value of goodwill is not necessarily what a willing buyer would pay for it. See, e.g., Marriage of Winn, 98 Cal. App. 3d 363, 159 Cal. Rptr 554 (1979); Marriage of Watts, 171 Cal. App. 3d 366 (1985); Marriage of Hargrave, 163 Cal. App. 3d 346, 209 Cal. Rptr 764 (1985).
38Another inequity in the treatment of business owners in a marital dissolution is the problem of double dipping, in which the same funds are distributed through an order for spousal support and in the equalizing payment to compensate the nonowner spouse for an interest in the business. The owner spouse also may be obligated to pay child support. The argument that accounts receivable should be included in the business valuation because the same funds would be paid as child and spousal support was rejected in In re Marriage of Marx, 97 Cal. App. 3d 552, 159 Cal. Rptr. 1224 (1979). See Adams, supra note 12, at § G.29.1.

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