Business Valuations – Value to the Owner?
The purpose of business valuations in Family Law is ascertain “the value to the owner but how does the “value to the owner” differ to that of “fair market value”?
Fair Market Value
Firstly, it is necessary to explain the definition and application of “fair market value”.
The definition of fair market value is commonly defined 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.
The hypothetical buyer and hypothetical seller proposition assumes that a hypothetical market exists and the business subject to the valuation can be transferred.
To the extent that there are limitations or restrictions on the ability to transfer the business in the actual market, the definition accommodates that by temporarily lifting the restriction to allow the hypothetical market to exist, but reflecting the actual existence of such limitations or restrictions by reference to the amount that may be agreed between the parties in recognition of the such impediments.
That is, the business valued assuming an open market and then discounts applied to the value to reflect any limitations or restrictions on the shares.
Development of the Value to the Owner
Where a minority interest was held in a family company, it was often argued that because there was no market for the shares, any value for those shares would be unrealisable. The cases often revolved around a family company, in which one party’s parents owned the majority of shares and the party owned a minority interest in that company. They argued that no third party would buy the shares because the company was controlled by the parents.
This approach only concentrated on the term “fair market value” with the emphasis on market rather than on the definition of fair market value. Under the definition of fair market value, we have a hypothetical seller and a hypothetical buyer. The definition does not define the identities and behaviour of the owner or buyer of the shares. The definition assumes an open and unrestricted market.
In business valuations using the Future Maintainable Earnings methodology, we are determining the value of an income stream. The methodology determines the value of the business and not the price at which it may change hands. The methodology makes no assumptions as to the price on sale. It represents the present value of the future income flows from the business. Value and price are often not the same, as price may reflect other benefits that ownership of the business may confer such as synergies with existing businesses, a job, the desire to be self employed, lifestyle decisions etc.
The principle of value to the owner has been well explained in Scott & Scott (2006) FamCA 1379 at 45:
After noting her own responsibility to determine the value of the husband’s interest on the whole of the material before the Court, including the divergent expert opinion, her Honour moved to consideration of each respective valuation methodology (at paragraph 42):
The concept of “value to owner” considers and takes into account the benefits to a particular owner even though this may not be based on a hypothetical third party purchaser. The cases of Reynolds and Reynolds (1985) FLC 91-632 and Turnbull and Turnbull (1991) FLC 92-258 dealt with the value of shares in a proprietary company. The Full Court also dealt with this issue in Harrison and Harrison (1996) FLC 92-682 where they approved the approach taken by the trial judge and quoted from her judgment as follows.
“The husband’s submission was that although the shares can be artificially valued they are valueless because unrealisable. This ignores the benefits which accrue to the husband through their ownership. Amongst those benefits are the right to receive dividends, which in the past have been substantial, the buffer of a loan account, the provision of a motor car, yacht and trailer, the contribution towards payment of certain household bills and the flexibility of being, if not self-employed, employed by a company in which he is share holder and director and whose ethos allows him a degree of autonomy. It also effectively ignores the assets of and business conducted by the companies and the reality of the husband’s interest in them.’
Her Honour then considered the relevant law, including the decisions in Hull and Hull (1983) FLC 91-360 , Turnbull and Turnbull (1991) FLC 92-258, Reynolds and Reynolds (1985) FLC 91-632 and Sapir v Sapir (No 2) (1989) FLC 92-047. On page 27 of the appeal book, the trial Judge then made the following significant finding:
`I am satisfied in the context of proceedings under the Family Law Act that when a judge is determining the value of shares held by a party in a family company, she or he must look at the reality of the situation and value the shares on the basis of their worth to the shareholder. In this case, the husband’s shares can only be valued on the basis of their worth to him in the context of the Harrison family as a whole. That worth is substantial.
and Watt J. in Clarkson & Clarkson  FamCA 1098
208.The authorities indicate that valuations performed pursuant to the value to owner objective consider benefits arising from ownership which encourage retention thereof for an indefinite period. It is therefore necessary to evaluate the likelihood of the party opting to sell his or her shares. Cases such as Hull, Reynolds and Ramsay and Ramsay (1997) FLC 92-742 indicate that if a party is likely to retain his or her shareholding, the appropriate objective for valuation is value to owner, on the basis that a benefit is derived over and above an eventual sale price.
Warwick J. in AJW v JMW (2002) FLC 93-103:
23. As I indicated in Ramsay v Ramsay (1997) FLC ¶92-742 where there is a market for shares, evidence of market value may well be one and the same as ”value to the owner”.
The value to the owner concept provides an important distinction in Family Law where the ownership of a business and the associated benefits are likely to continue. The concept of “value to the owner” is not exclusive of the “fair market value” definition and commonly accepted business valuation methodologies.