Divorce Valuation Hinges on Expert Credibility
A recent Nebraska divorce case, Cain v. Cain, illustrates how differences in experts’ assumptions can have a dramatic impact on valuations. The main issue was the value of the husband’s 50% interest in a roofing business as of December 31, 2018.
Battle of the Experts
Both experts relied on a capitalization of earnings approach. However, the husband’s expert also used the asset and market approaches as “sanity checks.”
In estimating the company’s cash flow, each expert adjusted revenue for certain management fees. Those fees — which ranged from $271,000 in 2015 to more than $2 million in 2018 — were paid to a company the two co-owners used as a “payroll paying entity,” apparently to save on taxes by shifting income from one entity to the other.
5 Key Assumptions
The experts’ approaches were similar. But the court noticed five critical differences in their assumptions:
- Salaries. In estimating cash flow, the wife’s expert assigned each owner a $150,000 annual salary. The husband’s expert assigned salaries to the husband and his co-owner of $374,470 and $273,996, respectively.
- Expenses. The wife’s expert excluded a $295,539 bad debt expense in 2018, finding it to be nonoperating and nonrecurring. He also excluded a $16,000 charitable contribution in 2018 as a discretionary expense. The husband’s expert included both expenses.
- Cash flow. The wife’s expert used cash flows for 2016, 2017 and 2018, weighted equally. He argued that the most recent three years were the best predictors of future performance. The husband’s expert used cash flows from 2014 through 2018, but he assigned greater weight to the more recent years.
- Cost of equity. The wife’s expert calculated the company’s cost of equity capital to be 19%, from which he derived a capitalization rate of 14.67%. The husband’s expert determined the cost of capital to be 21.9%, from which he derived a 19.1% capitalization rate.
- Valuation discounts. Both experts applied a 5% discount for lack of control. But the wife’s expert applied a 15% discount for lack of marketability, whereas the husband’s expert applied a 20% discount.
Based on these assumptions, the husband’s expert valued the 50% interest at $494,000. In contrast, the wife’s expert valued it at $2,525,000 — more than five times the opposing expert’s conclusion.
Court Decisions
The wife’s expert also provided the court with an alternative valuation of $1,830,500. In arriving at his valuation conclusion, the wife’s expert didn’t factor in certain nonowner wages paid by the payroll entity. He explained that he couldn’t determine whether those wages were solely for services to the roofing company. If the court were to determine that they were, then the company’s value should be lowered to the alternative amount.
The trial court adopted the wife’s expert’s alternative valuation of $1,830,500. And the Court of Appeals of Nebraska affirmed the trial court’s decision. The appellate court found that the valuation accepted by the trial court wasn’t unreasonable. Further, the court ruled that differences between the experts’ conclusions “reflect [their] different perspectives and independent exercise of professional judgment.”
Credibility is Essential
Although both parties provided extensive evidence, the trial court found the valuation by the wife’s expert to be more credible. “It is not our role to second-guess the [trial] court’s determinations of weight and credibility when presented with a conflict in plausible evidence,” explained the appellate court. This lesson is universal: The credibility of a business valuation expert is a top concern in Nebraska divorce cases and beyond.