CPAs are frequently called upon to provide valuation services in connection with marital dissolution matters. But divorce between husband and wife isn't the only dissolution that requires CPA expertise. Increasingly, CPAs are being called upon to provide valuation services for corporate dissolution.
In the simplest terms, a corporate dissolution action commences when a shareholder (or group of shareholders) proves the existence of certain facts set forth in Chapters 18 or 19 of the California Corporations Code and brings an action for corporate dissolution. Examples of factual requirements include the extent of share ownership and proof of issues such as voting deadlock, persistent and pervasive fraud, mismanagement, or unfairness by the remaining shareholders.
If the complaining shareholder prevails in the action to dissolve the corporation, the remaining shareholders, or the corporation, may purchase the complaining shareholder's shares under CCC Sec. 2000. The valuation assignment that arises from this action requires that the CPA possess expertise beyond the more typical fair market value assignment.
The standard of value in a Sec. 2000 engagement is "fair value," not "fair market value."
Fair value is a well-known valuation standard, but by its very definition it does not have a universal meaning. Fair value was created to facilitate valuations performed under specific instructions promulgated by a legislative body or other overriding source, often in the context of litigation. For example, valuations performed in the context of marital dissolution are subject to the fair-value concept. In that instance, the meaning of fair value varies with the law from state to state. Thus, the appraiser must understand the pertinent legal issues in a given jurisdiction before commencing work. The meaning of fair value in a Sec. 2000 engagement is similar in this regard.
Since fair value is subject to interpretation and is typically encountered in litigation matters, the appraiser may receive contradictory explanations of its meaning. For this reason, it is important for the appraiser to develop an independent understanding of the term.
If appraisers solely rely on the attorney who hired them to explain the meaning of fair value, they risk performing a valuation that could be challenged due to a misapplication of the law. An exaggerated, but not entirely unrealistic, portrayal of valuation instructions given to a CPA by the attorneys in a Sec. 2000 engagement is as follows.
TWO ATTORNEYS, TWO VIEWS
The purchasing party's attorney might present this case: "The minority (complaining) shareholder brought an action to have this corporation dissolved. Thus, the minority should receive nothing more than if his wish was granted and all assets were liquidated and debts paid. In performing this liquidation calculation, you should include all associated costs, such as commissions, fees and taxes. Keep in mind that the corporation would have filed notice for liquidation and ceased all activities. Thus, it is very unlikely that all assets would have been sold or liquidated at anything close to their market values. If you believe there was the possibility of selling the business as a whole, keep in mind that this had to be accomplished in a limited timeframe for cash. Since the buyer would have been aware of the distressed nature of the sale, he or she would have required significant discounts. Finally, keep in mind that this business had no covenants or employment agreements with the shareholders, and it is unlikel y that a buyer would have paid much for intangible value without these assurances."
On the other hand, the complaining party's attorney might have this perspective: "The statutes are designed to protect the minority shareholder against the injustices of the controlling shareholder. Thus, the valuation process must ensure that the controlling shareholder is not unjustly enriched by a buyout of the minority. You should value the stock as if the corporation was sold as a going concern to the highest bidder in a hypothetical market. There is no time limit on such a sale, and you should appraise the stock as if the directors could have waited for an optimum time in the market to achieve the best possible result. Also, remember that the phrase 'liquidation value' in the CCC does not suggest a piecemeal liquidation under any circumstances. You should presume that all existing employees were bound to the corporation by both employment agreements and covenants not to compete. If the value is highest to the shareholders, you should assume they are the buyers. Reductions in value for issues such as li quidation costs, income taxes and lack of control are strictly prohibited."
In the above examples, the attorneys are advocating the most favorable positions for their clients. A more reasonable interpreta2tion of fair value would comprise portions of each of their comments. For example, it is clear from certain appellate cases (see box) that fair value should not be reduced for issues such as liquidation costs, income taxes, or lack of control. Likewise, the appraiser should assume that a covenant not to compete exists and therefore not discount the value for reliance of the business on the personal attributes of the controlling shareholder. Further, the valuation must be performed as if the buyer paid cash for the business and its assets. Finally, the appraiser cannot assume that the directors can time the market for an unusually long period to bring the highest possible value. This stated, there is no rule that imposes an immediate timeframe on the process.
COURTS PROVIDE GUIDANCE
The courts also provide guidance on other subtle, yet critical valuation concepts. One such concept addresses the hypothetical stock buyer. Some attorneys suggest that the business must be valued as in a piecemeal liquidation unless a specific buyer can be located and identified. There appears to be little basis for this premise in either fact or law. Factually, it is often unfeasible to locate a "real" buyer for a company that is not legitimately for sale.
In addition, there is nothing in the statute or cases that directs the appraiser to identify a specific buyer. Rather, the appraiser should determine whether the corporation reasonably could be assumed to have value to a hypothetical buyer, and to "... consider the manner in which the parties to such a hypothetical sale are most likely to maximize their return." [Abrams v. Abrams-Rubaloff & Associates, Inc. (1980) 114 Cal.App.3d 240.]
The valuation of closely held stock in a Sec. 2000 proceeding is one of the more interesting and intellectually challenging valuation assignments that an appraiser can engage in. The appraiser must intimately understand both valuation theory and law as it applies to the valuation process. These engagements offer the appraiser outstanding opportunities for rewarding and profitable work.
Mark Luttrell, CPA, ABV, is managing partner of Sprayberry, Barnes, Marietta & Luttrell, a wholly-owned subsidiary of Century Business Services, Inc. He is past chair of CalCPA's Business Valuation Section and frequently lectures on business valuation issues at national and state seminars.
WHERE TO FIND MORE INFORMATION
OVERVIEW OF CALIFORNIA CORPORATE DISSOLUTIONS
While this article gives a basic introduction and overview of the law and valuation concepts in this area, you should be intimately familiar with the issues before beginning such an engagement.
An excellent starting point is a discussion paper entitled, "Business Valuations Under California Corporations Code Section 2000" published in April 2000 by CalCPA's Business Valuation Section. In particular, the reader should study the appendices of the discussion paper, which include full-text copies of the relevant appellate cases and statutes that are critical in understanding the unique valuation issues in a Sec. 2000 engagement.
To understand the concept of fair value in the State of California, required reading would include the following California appellate cases: Brown v. Allied Corrugated Box Co. (1979)91 Cal.App.3d 477, Abrams V. Abrams-Rubaloff & Associates, Inc. (1980) 114 Cal.App.3d 240, and Ronald v.. 4-C's Electronic Packaging, Inc. (1985) 168 Cal.App.3d 290. In addition, the appraiser should read Chapters 18,19, and 20 of the California Corporations Code.
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|Author:||LUTTRELL, MARK S.|
|Date:||Nov 1, 2000|
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