Opinion ID: 2353423
Heading Depth: 1
Heading Rank: 3

Heading: valuation of the machine shop

Text: Both parties used appraisal experts to evaluate NEPP. Bernard McTeague testified for the plaintiff that by using the capitalization of income approach the company had a value of $250,000 as a going concern. Robert Hadley testified for the defendant that in his opinion the company had a greater value if it were liquidated than if it remained a going concern and that by using the liquidation approach he arrived at a figure of $133,000. The reasons Hadley gave for rejecting the income approach were that the average net earnings of the company for the years 1974 through 1979 were too low to justify treating it as a profitable enterprise, that the company is a one-man business and that without the defendant's knowledge, local contacts and management skills it was not likely that the business would continue. The referee, however, accepted the McTeague valuation. The referee admitted into evidence a document containing financial projections of NEPP for the years 1979 and 1980. This document, which was prepared by certified public accountants from estimates and assumptions made by the defendant, had been submitted by the defendant to the Connecticut development commission as part of a loan application made to the commission by NEPP. The defendant challenged the admission of the document on the ground of relevancy, arguing that in view of the admission of other exhibits showing the actual earnings of the company for the year 1979 and for the first nine months of 1980 the defendant's projections should be rejected as worthless. The defendant's downgrading of his own financial estimates need not be accepted at face value. The fact that the defendant thought enough of these projections to use them as a basis for a substantial loan application suggests that they were entitled to be taken seriously. Additionally, an examination of the projection for 1979 when compared with the actual results for that year demonstrates that, if anything, the projection was on the conservative side, showing, for example, gross sales of $540,000 and net income of $23,000 as against actual sales of $599,000 and actual net income of $73,500. Relevant evidence must be logically probative and sufficiently significant to aid the trier in the determination of a fact in issue. Pitt v. Kent, 149 Conn. 351, 357, 179 A.2d 626 (1962). In determining whether a specific piece of evidence is relevant the trial court exercises a broad discretion. Delott v. Roraback, 179 Conn. 406, 414, 426 A.2d 791 (1980). In admitting the document in question the trial court acted well within its discretion. The defendant challenges the court's acceptance of McTeague's valuation of the machine shop on two grounds. First, he asserts that there was an insufficient factual basis for utilization of the income approach. Second, he contends that even assuming the appropriateness of the income approach, the use by McTeague of an erratically high earnings year (1979) as an income base produced a distortion in the capitalized value of the business. In assessing the value of ... property ... the trier arrives at his own conclusions by weighing the opinions of the appraisers, the claims of the parties, and his own general knowledge of the elements going to establish value, and then employs the most appropriate method of determining valuation. Esposito v. Commissioner of Transportation, 167 Conn. 439, 441, 356 A.2d 175 [1974]; Textron, Inc. v. Wood, 167 Conn. 334, 345, 355 A.2d 307 [1974]. The trial court has the right to accept so much of the testimony of the experts and the recognized appraisal methods which they employed as he finds applicable; his determination is reviewable only if he misapplies, overlooks, or gives a wrong or improper effect to any test or consideration which it was his duty to regard. Greenfield Development Co. v. Wood, 172 Conn. 446, 451, 374 A.2d 1084 (1977). We have approved the capitalization of actual income as an appropriate method of valuation. Uniroyal, Inc. v. Board of Tax Review, 174 Conn. 380, 386, 389 A.2d 734 (1978); Somers v. Meriden, 119 Conn. 5, 7-8, 174 A. 184 (1934). In the present case the defendant's company was, at the time of its valuation in 1980, a going concern. There was no evidence that it was in the process of liquidation. Although the trier was not obliged to accept the income approach he was not precluded from doing so merely because the company is a closely held, one-man business. The defendant does not seriously challenge the use of the income approach for valuation of a going concern. Indeed, the defendant's expert, Hadley, utilized this approach but rejected the valuation based on it because, in his view, an appraisal of the assets using the liquidation value approach would produce a higher valuation. Since both McTeague and Hadley agreed that a capitalization multiplier of five would be appropriate, the narrow issue before us is whether there is any evidence in support of a finding of annual net earnings of $50,000. In reaching his conclusion that the basic after-tax annual earning power of the company was $50,000, McTeague relied on the financial statements of the company for the years 1977, 1978 and 1979. These showed sales of $325,000, $404,000 and $600,000 respectively, officer's compensation of $25,000, $32,000 and $36,000 and net income of $3000, $7800 and $74,000. McTeague also relied on the defendant's projections for the years 1979 and 1980 which showed sales of $540,000 and $650,000, officer's salary of $39,000 and $40,000 and a net income of $23,000 and $55,000. Finally, McTeague relied on his analysis of the upward trend of the company business during the years he examined, his knowledge of economic data specifically relating to the metal products industry and his familiarity with general economic conditions. Fair market value, that is, the price that would probably result from fair negotiations between a willing seller and a willing buyer; Gebrian v. Bristol Redevelopment Agency, 171 Conn. 565, 571, 370 A.2d 1055 (1976); involves a question of fact. Id. As with other questions of fact, unless the determination by the trial court is clearly erroneous, it must stand. Kaplan v. Kaplan, 186 Conn. 387, 392, 441 A.2d 629 (1982); Pandolphe's Auto Parts, Inc. v. Manchester, 181 Conn. 217, 221, 435 A.2d 24 (1980); Practice Book § 3060D. It is generally recognized that closely held corporate stock cannot be valued reasonably by the application of any inflexible formula. Snyder's Estate v. United States, 285 F.2d 857, 861 (4th Cir. 1961); O'Malley v. Ames, 197 F.2d 256, 258 (8th Cir. 1952); annot., 22 A.L.R. Fed. 31, 44 et seq. Since valuation of securities is, in essence, a prophecy as to the future; Revenue Ruling 59-60 § 3 (26 C.F.R. 2031-2032); it is important that the prognostication be based on an examination of the appropriate financial tea leaves. While prior earnings records usually are the most reliable guide as to future expectancy, resort to arbitrary five or ten year averages without regard to recent trends is not likely to produce a realistic valuation. Id., § 4.02(d). In a closely held corporation, where profits are more likely to be distributed in the form of salaries and fringe benefits, the amount of surplus available for distribution in the form of dividends may be of little or no consequence. The financial statements of the company from 1977 through 1979 show a steady increase in gross sales. These statements also reflect a steady increase in compensation for the defendant during the same period. There was also evidence before the trier that, in 1980, compensation to the defendant by way of salary and other benefits amounted to $70,000. The defendant's projection for 1980 showed gross sales of $650,000 and a net income of $55,000. Taking all of these factors into account it cannot be said that the trial court's acceptance of the $50,000 annual earning figure, even if somewhat high, was clearly erroneous. The defendant makes the point that the actual financial figures for the first nine months of 1980 demonstrate that the rosy picture portrayed in 1979 was an aberration, an erratic spike in an otherwise rather flat economic condition and that the defendant's own projection for 1980 bore very little relationship to reality. If the defendant's point were well taken it would call for reexamination of the trial court's conclusions. But the defendant's point is not well taken. In January, 1980, the dissolution proceeding was instituted. That same month the defendant withdrew $35,000 from the company. In May, 1980, he put his elderly retired father on the payroll at the rate of $200 per week. He also took over the bookkeeping functions of the company. His bookkeeper testified that the defendant told her there were ways you could put things on paper to make a company look as though it wasn't operating with a good, you know, a profit, and that he was going to try to figure out ways that could do this. He also stated that he had deliberately falsified his 1980 cash receipts ledger. Finally, it is interesting to note that, whereas in previous years the average gross profit was approximately 37 percent of gross sales and was projected by the defendant for 1980 at 36 percent, the actual gross profit for the nine month period is only 7 percent of gross sales of approximately $300,000. [1] It would not require unusual skepticism to view the 1980 financial statement with an abundance of reserve.