Valuation

June 27, 2016

Goodwill Valuation is Key in Professional Partnership Valuations

The limited liability partnership or LLP is a highly popular form of business association for professional practices including law firms and medical groups. As its name suggests, the LLP combines the attributes of a partnership with the limited liability traditionally associated with corporations, except that professionals in LLPs generally remain personally liable for their own misconduct or negligence.

See How to Avoid Bad Blood Over Goodwill in Professional Partnership Valuations

This is a story about a recent case involving a fight over the inclusion or exclusion of goodwill in valuing the interest of a retired partner in a medical practice organized as a limited liability partnership, and how it easily could have been avoided.

October 28, 2013

Ownership Stake Conceded in Business Divorce Case

by Jay R. McDaniel, Esq.

Appellate courts usually defer to a trial court’s factual findings in a business divorce case that
makes it to trial. Here is a rare decision, however, in which the Appellate Division reversed the factual determinations of the trial judge, finding that the disputed ownership interest had been conceded by one of the parties.

Limited Liability Company Decision is Reversed

The case, Surgem LLC v. Adhievmed, Inc., Docket No-A4198-11T! (October 16, 2013) involved a dispute between a successful surgeon, John Hajjar, who established a chain of same day surgical centers and his former business partner, John Seitz. The businesses, and the relationships, were poorly documented, however, and the outcome turned on the issue of whether the parties had made an oral agreement.

We represent clients in the formation stages of limited liability companies as well as during disputes. Consult with us about limited liability operating agreements and disputes between members.

LLC Operating Agreement

Notably absent from the Appellate Division opinion is any mention of the terms of the LLC’s operating agreement. It appears that this is another case in which the owners of a business failed to document the basic details of their relationship and the trial court had to fashion a decision from evidence that was equivocal – or so the trial court thought.

December 31, 2012

Five Expensive Mistakes When Forming a New Jersey LLC

by Jay R. McDaniel, Esq.

New Jersey Limited Liability Company Attorneys

Imagine that the limited liability company you and your partners started five years ago is involved in a nasty corporate governance lawsuit. Perhaps one of the partners needs to be expelled, or maybe one of the owners is involved in a competing business. Imagine that you are spending tens of thousands of dollars every month on legal fees, that the business is in a state of constant disruption and that you haven’t had a good night’s sleep in weeks.

And now, accept the fact that this could have been avoided.

The chances are that if a closely held business is involved in this type of litigation it is because the owners did not plan well when they started the business. How do I know? Having litigated many of these matters over the years, I see the same mistakes made early in the life of the business surfacing again and again as the source of litigation.

New Jersey Limited Liability Company Operating Agreement

This is my non-exclusive list of what I think are the most expensive mistakes that I see people make in their business. There are others, to be sure, but these are the ones that I see as the source of litigation among the members.

No Operating Agreement: Actually, I am not going to count not having an operating agreement as one of the five “mistakes.” It is not really a mistake, it is a colossal blunder, kind of like drunk driving – you may get away with it for a while, but you know how it’s going to end.

November 1, 2011

Chancery Court Rejects ‘Inconceivable’ Value in Shareholder Buyout

by Jay R. McDaniel, Esq.

Sometimes an expert valuation opinion, however well documented, leads to a conclusion that just doesn’t square with reality. That was the case with an expert opinion in Rughani-Shah v. Noaz, Docket No. A-4943-08T2 (Sept. 16, 2011) that valued a one-third interest in a medical practice at just $25,000. The trial court’s decision was affirmed by the Appellate Division of New Jersey Superior Court.

The trial judge didn’t buy it – not when the practice was grossing $1.7 million a year and not when the buy-in for the shareholder seeking the buyout had been eight times that amount. Common sense said the number was just too low, and the expert’s opinion was rejected.

October 26, 2011

Partnership Accounting Not Available from Deceased Partner’s Heirs

by Jay R. McDaniel, Esq.

Uniform Partnership Act Limits Remedy

If a partner dies after having allegedly misappropriated partnership funds, do the other partners have a right to pursue his estate? The answer appears to be no, according to a recent Chancery Court decision.

The decision in In re Genet, Docket No.: ESX-C-44-11 (Oct. 13, 2011) was decided under the now repealed Uniform Partnership Act – yet another warning to partnerships formed before December 2000 that if they want the newer law to apply, they should amend the partnership agreement to say so.

In granting a motion to dismiss the claim of the surviving partner seeking to require his nieces to account for the misappropriations of their father, Chancery Judge Walter Koprowski held that the statutory language that created an obligation of the partnership to account to the estate of a deceased partner was not reciprocal. It did not create a similar obligation of the estate to account to the partnership for the wrongful acts of the deceased partner.

August 19, 2011

Book Value is Not Fair Value in Partnership Buyout

by Jay R. McDaniel, Esq.

Socialite’s Family Partnership Interest

Book value can have a few different meanings. The best definition is simply the value of assets and liabilities that a company carries on its books. Is it different than the “fair value” standard applied in statutory buyouts? Yes– a lot different.

There are many partnership agreements and corporate buy-sell agreements still in effect with a book value buyout provision. They tend to be older entities, often involving family businesses, and I cringe whenever I look at the agreement and see the term applied to the company’s value.

Book Value Used to Buy Socialite’s Interest

A recent decision involving the estate of socialite Claudia Cohen demonstrates why. Estate of Claudia Cohen v. Booth Computers, et al., Docket No. A-0319-09T2. Estate of Cohen App Div.pdf. (Thanks also to Peter Mahler’s NY Business Divorce blog for finding the trial decision. Cohen Chancery Div.pdf.) In that decision, the Cohen’s estate argued that the book value of a successful business was just less than 2 percent of its fair value – $ 178,000 as opposed to $11.526 million – and sought to reform the partnership agreement. The effort failed and the Appellate Division affirmed the trial court’s enforcement of the agreement. The disparity between book value and fair value was not, in the court’s opinion, reason to alter an otherwise unambiguous document.

The result was a windfall for the last surviving partner, Claudia’s bother James, and the same result is likely to occur in most agreements that set the value of the business at book value rather than fair value.

The Cohen case involved a partnership formed by the late Robert Cohen, an entrepreneur who amassed a considerable fortune through various entities including the Hudson News Group. He had three children – Claudia, Michael and James. Claudia, well known in Manhattan and Hamptons social circles, was also an editor of Page 6 of the New York Post and the ex-wife of entrepreneur Ronald Perelman.

The estate, with Perelman as executor, brought suit against Booth Computers and Claudia’s brother, James, after Claudia’s interest in a family partnership was valued at a fraction of the fair value of the partnership’s holdings.

May 27, 2011

Oppressed Shareholders Avoid Key Person Discounts

by Jay R. McDaniel, Esq.

This case goes into the “be careful what you say” category – particularly when it’s under oath, and particularly when you are involved in an oppressed shareholder action, or any other type of business divorce, for that matter.

Oppressed Shareholder Litigation

Oppressed shareholder actions almost invariably involve the purchase of the interests of some of the principals based upon valuations prepared by experts. One of the issues that the valuation expert will consider is whether a discount (or reduction in value) should be applied for the loss of a key person.

The inclination of the oppressed shareholder is to insist that they were absolutely critical to the success of the business, while the controlling shareholders insists that the shareholder who was forced out or frozen out was of no use anyway.

There is no bonus for being important to the business in valuation proceedings. In fact, the opposite is true. It runs contrary to the emotions of the parties and is completely counterintuitive to non-lawyers. For example, the big rainmaker who accounts for 80 percent of his professional firm’s business, but has somehow gotten frozen out of the enterprise, should keep his opinion about the extent of the contribution to himself or herself. The fact is that the enterprise is worth a lot less without them around, and that decrease in value may be reflected in a lower price for the purchase of their interests.

Key Person Discounts

There is surprisingly little case law on this topic in either New York or New Jersey and I am surprised that the issue does not come up more often between feuding principals. Yet you can have the unexpected situation in which a controlling shareholder fires key sales people and then asserts that they were absolutely critical – i.e., “key persons” – to the success of the business.

That was the case recently when the Supreme Court of New York County reviewed an application of this discount, which revealed an interesting point of the very personal nature of business divorce. Matter of Abraham (Elite Techonology NY, Inc.), 2010 NY Slip Op 33225(U) (Sup. Ct. NY County Nov. 10, 2010), (opinion here) (Thanks to Peter Mahler’s NY Business Divorce blog for finding the decision and publishing the referee’s report).

The key person discount, in the context of business valuation, is defined by….

April 12, 2011

LLC Does Not Distribute Clients on Dissolution

by Jay R. McDaniel, Esq.

When a limited liability company dissolves, it pays its creditors and distributes the remaining assets in the winding-down process. Many professional practices are organized as LLCs, and their principal assets are the clients they serve. That does not mean, however, that the professional limited liability company in dissolution has to divide up the clients.

This is an important holding for lawyers, accountants, doctors and other professionals that are practicing in New Jersey as a limited liability company. According to a New Jersey appeals court, the clients that the professionals, such as an accountant, bring to the LLC represent personal goodwill that belongs to the individual professional, rather than goodwill belonging to the enterprise. Thus, clients of professional limited liability companies are not considered assets of the LLC and on dissolution are not subject to distribution.

Accountants Seek Dissolution of Firm

January 24, 2011

Court Defers to Management’s Liquidation Value in Dissenting Shareholder Value

by Jay R. McDaniel, Esq.

The Business Judgement Rule presumes that a decision made by a majority of the board of directors in business matters is entitled to deference. Courts generally will not interfere with decisions that fall under the Business Judgment Rule.
Courts disregard the Business Judgment Rule when there is evidence of bad faith, misconduct or self dealing.
Even in a case involving the fair value of the shares of a dissenting minority shareholder, a court may consider the transaction at ‘arms length’ and defer to the board’s discretion.

August 13, 2010

An Early Cost-Benefit Analysis in Business Breakups Will Keep Dispute in Perspective

by Jay R. McDaniel, Esq.

When one or more of the owners of a business think it is time to get divorced, the decision in invariably accompanied by hard feelings. As most clients ultimately learn, the courts are incapable of resolving emotional issues. But they deal pretty well with money – which is why it makes sense to find out how much is at stake in the fight that is likely to ensue. Save the emotions for therapy; money is what the case is about.

The Pitfalls of Misinformation

My experience is that most clients are pretty thoroughly misinformed about the “fair value” of their business as well as their individual interests. Not infrequently, clients will presume that the high price-to-earnings ratio that one may find in the market of publicly traded stocks will apply equally to their closely held business. Not so. Others will fail to recognize the effect that the unusually high salaries paid to the owners will likely have in inflating the value of the business.

Limited Liability Company Decision is Reversed

LLC Operating Agreement

New Jersey Limited Liability Company Attorneys

New Jersey Limited Liability Company Operating Agreement

Uniform Partnership Act Limits Remedy

Socialite’s Family Partnership Interest

Book Value Used to Buy Socialite’s Interest

Oppressed Shareholder Litigation

Key Person Discounts

Accountants Seek Dissolution of Firm

The Business Judgement Rule presumes that a decision made by a majority of the board of directors in business matters is entitled to deference. Courts generally will not interfere with decisions that fall under the Business Judgment Rule.

Courts disregard the Business Judgment Rule when there is evidence of bad faith, misconduct or self dealing.

Even in a case involving the fair value of the shares of a dissenting minority shareholder, a court may consider the transaction at ‘arms length’ and defer to the board’s discretion.

The Pitfalls of Misinformation