Attorneys and their clients sometimes ask professional valuators to provide preliminary estimates, called “calculations”, rather than full-fledged business appraisals, formerly known as a conclusion of value. While such requests might save money up front, a recent Iowa case, In re Marriage of Hagar, illustrates why calculations are not a substitute for valuations.
Dry cleaners divorce
Jodi and Michael Hagar married in July 1999. In December 1999, Jodi quit her job as a publishing sales representative and joined Michael at Goliath, Inc., where he had worked since 1996.
Goliath was established by Michael’s parents to operate a dry cleaning business. In 1996, the parents formed Hagar, Inc. to purchase real estate and distribute income to themselves. Goliath remained the dry cleaning operating entity and leased its buildings and land from Hagar, Inc. In December 2000, the parents’ CPA, Ron Helle, roughly estimated Goliath’s value at about $500,000.
In January 2002, Michael entered into a purchase agreement and note to purchase Goliath for $300,000 from his parents’ trust, which held all of the Goliath stock. Over the course of the marriage, Jodi and Michael reduced the note obligation to $160,000, creating $140,000 in equity.
When they divorced, the trial court found that Helle, who testified in court, estimated Goliath’s value to be between $71,000 and $120,000. Neither party presented formal valuation testimony from a qualified valuation expert. In fact, Helle testified that his “computation” was not a valuation. Eventually the court determined that the business’s value was $95,500.
Court of appeals decides
On appeal, Michael claimed that the trial court had overvalued Goliath. He argued that Helle had provided an upper range of $71,000, and a lower range of negative $120,000. Jodi, on the other hand, asserted that the court had undervalued Goliath. She pointed out that the company had been “valued” at $500,000 in December 2000 and that half of the purchase price had been paid off.
The court of appeals agreed with both of them. It held that the $120,000 figure had been expressed as a negative number, as Michael contended. But it rejected Helle’s calculations (which the CPA himself described as “thumb-nail”) because he admittedly hadn’t used “judgment” or recognized the family relationship between Goliath and its landlord.
The court found that Goliath and Hagar were, first and foremost, operated to benefit the family. For example, one unprofitable Goliath location wasn’t closed as quickly as it could have been because the rent paid on it benefited Michael’s parents. A qualified expert would have incorporated such factors in a thorough valuation.
Real cost revealed
Goliath was ultimately valued at $140,000, about $70,000 more than the highest calculation provided by the CPA. Don’t risk such a discrepancy in your own cases – get a thorough valuation.
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