EQUITABLE DISTRIBUTION - VALUATION

1. EQUITABLE DISTRIBUTION - VALUATION LAW & VALUATION WAKE FOREST UNIVERSITY LAW SCHOOL April 14, 2004 A. Doyle Early, Jr.

2. What is the Standard of Value for Equitable Distributionin North Carolina? A. Fair Market Value - Poore v. Poore (1985) B. Investment Value C. Intrinsic Value - Fountain v. Fountain (2002) D. Fair Value - Hamby v. Hamby (2001) Royals v. Piedmont Electric E. Going Concerns Value F. Liquidation Value G. Book Value/Adjusted Book Value H. Net Value - Beightol v. Beightol (1988)

3. Fair Market Value Rev. Ruling 59-60 The price at which property would change hands between a willing buyer and a willing seller, when the former is not under any compulsions to buy and the latter is not under any compulsions to sell, both parties having reasonable knowledge of relevant facts. Carlson v. Carlson (1997)

4. Classification AndDate of Valuation 1. Marital 2. Separate 3. Divisible N.C.G.S. �50-20(b) 1, 2 and 4

5. Real Estate Valuations A. Direct Sales Comparison Approach B. Income Approach C. Cost Approach

6. Valuing Personal Property 1. By the Parties/Affidavits 2. By an Appraiser 3. Publications 4. Court Valuations

7. Valuing Stock Options 1. Intrinsic Value - Fountain v. Fountain (2002) 2. Black Scholes Method

8. Valuation of Life Insurance 1. Cash Surrender Value 2. Fair Market Value - Surles v. Surles (2002)

9. Valuation of Pension, Retirement and Deferred Compensation Benefits Types of Plans A. Defined Contribution B. Defined Benefit C. Vested D. Non-Vested

10. Vested and Non-Vested Pensions Vested pensions may be payable: 1. As a lump sum by agreement; 2. Over a period of time in fixed amounts by agreement; 3. By appropriate Domestic Relations Order as a prorated portion of the benefits made to the designated recipient at the time the party against whom the award is made actually begins to receive the benefits; or 4. By awarding a larger portion of other assets to the party not receiving the benefits and a smaller share of other assets to the party entitled to receive the benefits. Non-vested pensions may be payable: Same as 1, 2 and 3, but not 4.

11. Determining Present ValueBishop v. Bishop (1994) 1. Determine the amount of monthly benefit that would be received at retirement age if party had retired on date of separation 2. Determine the life expectancy 3. Determine the appropriate discount rate 4. Calculate present value 5. Use of PBGC Tables

12. Example of Valuation ofDefined Benefit Plan $5,820 Annual benefit at age 65 7.5% PBGC interest rate on the date of separation Table IV-A for 7.5% - PBGC actuarial value of $1.00 per year deferred to age 65�and payable for life thereafter -- healthy lives 3.486 PBGC interpolated actuarial factor $19,564.51 Annual benefit x PBGC factor 79% Coverture fraction (15/19) $15,455.96 Present value of defined benefit after applying coverture fracture 39.5% Prorated benefit at date of retirement

13. Valuing Closely Held Corporations and Professional Practices �Further, in reviewing the trial court�s valuation of an ongoing business or an interest therein for purposes of equitable distribution, the task of the appellate court is to determine whether the approach used by the trial court reasonably approximates the net value of the business interest�. If it does, the valuation will not be disturbed.� If no credible evidence is presented as to value of business, the court does not have to value it. Grasty v. Grasty (1997)

14. Factors to be Considered under Revenue Ruling 59-60 1. The nature of the business and the history of the enterprise from its inception. 2. The economic outlook in general and the condition and outlook of the specific industry in particular. 3. The book value of the stock and the financial condition of the business. 4. The earning capacity of the company. 5. The dividend paying capacity. 6. Whether or not the enterprise has goodwill or other intangible value. 7. Sales of the stock and the size of the block of the stock to be valued. 8. The market price of stocks of corporations engaged in the same or similar line of business having their stocks actively traded in the free and open market, either on an exchange or over the counter.

15. Approaches to Valuation 1. Income Approach A. Capitalization of Earnings B. Capitalization of Discounted Cash Flow C. Capitalization of Discounted Net Income 2. Asset Based Approach A. Adjusted Book Value B. Liquidation Value C. Capitalization of Excess Earnings (Rev. Ruling 68-609) 3. Market Comparable Approach A. Sales of Comparable Companies B. Arms-Length Transactions C. Prior Sales of Company Stock D. Consideration of Restrictive Agreement (Buy-Sell) - Fox v. Fox (1991) E. Use of Industry Standard Approaches (Rules of Thumb) - Smith v. Smith (1993) 4. Trial Court is permitted to average the approaches utilized by the experts - Sharp v. Sharp (1994) 5. To Challenge methodology, the party must object to the admissability of the evidence - Walter v. Walter (2002)

16. Capitalization of Excess Earnings (Revenue Ruling 68-609) 1. Average Earnings Normalized $ 50,000.00 2. Average Tangible Assets 200,000.00 3. Fair Percentage Return (10%) 20,000.00 4. Average Earnings Attributable to Goodwill or Excess Earnings (1. - 3.) 30,000.00 5. Capitalized Averaged Earnings Attributable to Goodwill at 20% (Multiply by 5 to get the value of Goodwill) 150,000.00 6. Add 2. And 5. For Total Business Value $350,000.00

17. Capitalization Rates 1. The rate used to convert income into an asset. 2. Determine the discount rate, which represents the total annually compounded rate of return the investor requires over the life of the investment. 3. Capitalization rate is discount rate minus long term growth. C = D - g 4. A capitalization rate reflects risk. 5. A capitalization rate may be expressed in a percentage or a multiple (I.e., a 25% capitalization rate results in a multiple of 4). 6. Capitalization rate equates to P.E. (Price Earnings Ratio) 7. Court can choose it�s own capitalization rate - Smith v. Smith (1994)

18. Build-Up Method 1. Risk-free, long-term (20 yr.) government bond rate 7.30% 2. Equity (common stock) risk premium 7.40% 3. Small company risk premium 5.10% 4. Specific company risk premium 8.00% (Determined by appraiser) 5. Discount rate 27.80% Less long-term growth of - 5.00% Equals Capitalization rate of 22.80%

19. Example of Weighted Value Year Net Income Weight Weighted Net Income 1985 $ 95,000 1 $ 95,000 1986 $102,000 2 $ 204,000 1987 $115,000 3 $ 345,000 1988 $140,000 4 $ 560,000 1989 $154,000 5 $ 770,000 Total $606,000 15 $1,974,000 $1,974,000 � 15 = $131,600

20. Restrictive AgreementWeaver v. Weaver (1985) 1. Presumptive Value 2. Reasonable or Rational Reflection of Value 3. Experience and History

21. Discounts or Premiums A. Minority Interest Discount v. Control Premium B. Lack of Marketability Discount (Liquidity) C. Discount for Loss of Key Man D. Discount for Trapped-In Capital Gains - Davis v. Commissioner (Discount allowed for trapped-in capital gains although there was no sale or contemplated sale of the asset on the date of separation.) E. But�Dolan v. Dolan (2002) - the value of commercial real estate should not be adjusted for capital gains distribution did not contemplate an immediate sale F. Clark v. Clark (1980) - Alimony G. Shannon Pratt

22. The Trial Judge as Gatekeeper for Expert Testimony 1. Daubert v. Merrell Dow Pharmaceuticals, Inc. (1993) Scientific testimony 2. Kumho Tire Co. v. Patrick Carmichael (1999) Expanded to technical or other specialized testimony 3. Howerton v. Arai (2003) Danbert applied in N.C. 4. Walter v. Walter (2002) Applies to valuation methodology if there is objections 5. Rule 702 - �If scientific, technical or other specialized knowledge will assist the trier of fact� a witness qualified as an expert� may testify hereto in the form of an opinion.� 6. Questions for the trial judge: A. Whether testimony is based on scientifically valid reasoning or methodology B. Whether the reasoning or methodology can properly be applied to the facts at issue 7. Factors to consider in determining admissibility: A. Whether theory or technique can be and has been tested B. Whether it has been subjected to peer review and publication C. The known or potential rate of error D. Whether the theory or technique has achieved general acceptance in the relevant field