Value to the Holder: How Divorce Impacts Businesses

One of the most difficult conversations I have with business owners going through a divorce is that their business does have a value. I was recently confronted with a woman who built a very successful consulting firm. She had seven employees, but she basically ran the firm and was responsible for the vast majority of the consulting engagements. I explained to her that the business would have to be valued and her husband would be entitled to a portion of that value. Essentially, even though her husband was not involved in the business, and without her the business would cease to exist, she would still have to write a check to her husband. She was adamant and explained the business had no value and was worth nothing without her.

Obviously, the business does have value to her. New Jersey courts have already weighed in on this issue; “value to the holder”. It means that there is a marital asset that is subject to equitable distribution.

Value to the Holder

Value to the holder States like NJ are generally those that look to identify the value the asset or assets created during a marriage as a result of joint efforts of both spouses, regardless of whether a marketable asset was created or not.

States that favor the value to the holder premise consider the cash flows received by the title holding spouse regardless of the assets’ transferability.

States that follow an investment value standard seemed to apply the notion that although the business may not be immediately salable and may not have value beyond its net tangible value without the owner employee in place, the business has an ongoing value to the owner and therefore to the marital estate.

In the value to the holder states, the view of property is broad and recognizes that the title holder will continue to function as an owner benefiting from the asset already in place.

Dugan vs. Dugan

One of New Jersey’s early cases concerning the treatment of goodwill shows the course reasoning for including elements of personal goodwill as marital property.

This case has citing decisions over 101 times, this is a strong indication that this is good case law.

Dugan vs. Dugan Case Summary

After a 20-year marriage the Dugan’s separated. Mr. Dugan was a member of the New Jersey Bar Association and continues to practice in a professional corporation.

Mr. Dugan appealed to the lower court judgment regarding property distributions. The New Jersey Supreme Court had to determine whether goodwill of Mr. Dugan’s law practice was an asset subject to equitable distribution, and, if so, how it should be evaluated. At the same time of this case 1983 New Jersey lawyers were not permitted to sell their goodwill.

New Jersey Supreme Court distinguished intangible assets from tangible ones, and those intangible assets have no intrinsic value but do have a value related to the ownership and possession of tangible assets. Intangible assets such as trademarks and patents are identified as intangible assets of goodwill is based on the reputation that will probably generate future business.

The court noted that goodwill is largely protected interest as evidenced by the ability to prevent the seller’s competition with a covenant not to compete. In addition, New Jersey inheritance tax requires consideration of goodwill. It has been recognized as an element of value and liquidation.

Goodwill can be turned into  perspective earnings and, from an accounting support standpoint, can be defined as the future estimate earnings that exceed the normal return on investment. The court distinguished goodwill and earnings capacity by stating that goodwill reflects not only the possibility of future earnings, but the probability based on existing circumstances and after divorce, the law practice will continue to benefit from goodwill as it had during the marriage. For the purpose of distribution, it would be inequitable to ignore the other spouse’s contribution to the development of a viable economic resource.

The court also acknowledged that limitations exist on the ability to sell a law practice with goodwill. However, the goodwill itself as significant value irrespective of limitations. The court found several problems with the valuation including the method of determining reasonable compensation. The court felt that the method used to determine the firm’s efficiency rather than the plaintiff’s reasonable compensation. Instead, the court noted the age, experience, education expertise, effort and locale should be elements considered in determining reasonable compensation. In addition, the value later added back too many expenses to the income stream used in the valuation and compared the attorney’s computation compensation to an average around the country rather than a specific area. The court also took issue with unsubstantiated capitalization rates.

The important concept established in the case is that goodwill has value if only to the holder, regardless of its marketability.