What is my business worth? You say $100,000, she says $1,000,000. Whether arguing with an irate spouse in the context of a divorce case or a business partner in a partnership dispute, the answer is often difficult and expensive to determine.
As the New Jersey Supreme Court observed in Balsamides v. Protameen Chemicals, Inc., 160 N.J. 352, 368 (1999) (“Balsamides“), and Lawson Mardon Wheaton, Inc. v. Smith, 160 N.J. 383, 397 (1999) (“Lawson“), valuation of a closely-held business is not an exact science. See also Bowen v. Bowen, 96 N.J. 36, 44 (1984) (quoting Lavene v. Lavene, 162 N.J. Super. 187, 193 (Ch. Div. 1978) (on remand) (Lavene II)); John R. MacKay, II, 2 New Jersey Business Corporations § 14-6(d)(1) (2d ed. 1996).
In Lavene v. Lavene, 148 N.J. Super. 267 (App. Div.), certif. denied, 75 N.J. 28 (1977) (Lavene I), where the Appellate Division held that the husband’s 43% interest in a closely-held corporation “constitute[d] a distributable asset” and remanded for valuation, Judge Pressler remarked:
There are probably few assets whose valuation imposes as difficult, intricate and sophisticated a task as interests in close corporations. They cannot be realistically evaluated by a simplistic approach which is based solely on book value, which fails to deal with the realities of the good will concept, which does not consider investment value of a business in terms of actual profit, and which does not deal with the question of discounting the value of a minority interest.
Id. at 275.
The valuation of a closely-held corporation is particularly difficult because the corporation’s stock is not available on the public market. Bowen v. Bowen, 96 N.J. 36, 44 (1984). The valuation is fact sensitive and “depends upon the experience of the appraiser and the completeness of the information upon which his conclusions are based.” Bowen, 96 N.J. at 44 (1984)(quoting Lavene II, 162 N.J Super. at 193); Steneken v. Steneken, 183 N.J. 290, 297-298 (2005). Thus, a court looks at the reasonableness of the valuation method in determining whether the valuation is adequate. Steneken, 183 N.J. at 297.
In fact, there is no single prescribed or even preferred method of valuing a closely held business. Steneken, 183 N.J. at 297. The New Jersey Supreme Court has endorsed the use of a trustworthy buy-sell agreement to establish value, noting that in some instances it may appropriately establish a presumptive value of a party’s interest. Bowen, 96 N.J. at 45-46 (1984) (citing Stern v. Stern, 66 N.J. 340, 346-47 (1975)). In the absence of a buy-sell agreement, to compute the value of a closely-held corporation both experts and courts frequently have resorted to the IRS’s Revenue Ruling 59-60 for guidance.
Among the factors listed in the Ruling as “fundamental and requir[ing] careful analysis” are the history of the firm, the nature of the company, the outlook for the industry, the book value of the stock, the size of the block to be valued, the earning and dividend-paying capacities of the company, and the existence of goodwill or other intangible assets. Ibid. Generally, greater weight will be given to earnings factors for those companies that sell products or services, and to asset values for investment or holding companies. Ibid. In addition, earnings factors must be capitalized. Choosing the appropriate capitalization rate is “one of the most difficult problems in valuation.” Id. at § 6. Among the considerations that go into a capitalization rate are the nature of the business, the risk involved, and the stability of earnings.
Bowen, supra, 96 N.J. at 44 (quoting Rev. Rul. 59-60, 1959-1 C.B. 237, § 4.01).
Generally, in determining fair value, the judge should consider “‘proof of value by any techniques or methods which are generally acceptable in the financial community and otherwise admissible in court.’” Balsamides, 160 N.J. at 375 (citations omitted). The judge may use any acceptable method to calculate the value, but he must determine that the chosen method yields the fair value of the shares. Hughes v. Sego International Ltd., 192 N.J. Super. 60, 68 (App. Div. 1983); Hamilton, Johnston, & Co., Inc. v. Johnston, 256 N.J. Super. 657, 672 (App. Div.), certif. denied, 130 N.J. 595 (1992).
In Balsamides, the Court held that 35% marketability discount was appropriate in valuing the shares of an oppressed shareholder of a closely held corporation in the context of a court ordered sale. The extraordinary circumstance that warranted use of a marketability discount in Balsamides was that it was the oppressing 50% shareholder who was to acquire the shares of the oppressed 50% shareholder, and equity demanded that the oppressor not be rewarded for his conduct by allowing a buy-out at a discounted price. In Lawson, supra, the Supreme Court found no comparably extraordinary circumstance and rejected use of the discounts where discounting would have allowed the oppressive majority shareholder to buy out minority owners at less than full value.
As the foregoing published decisions issued by the New Jersey Appellate Court and New Jersey Supreme Court demonstrate, establishing a value on a closely held business is complex and filled with many variables.