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Misvaluing small personal services businesses

A recent unpublished opinion Court of Appeals opinion, Herring-Wilson v. Wilson, highlights a common fallacy in valuing small personal services businesses for purposes of equitable distribution: treating personal goodwill as marital property. The Court of Appeals reversed a finding that Wife’s business had a value of $603,000 and requiring her to pay Husband half that amount as part of an equitable distribution award. As I’d represented Ms. Herring-Wilson in a brief period between trial and appeal, I was interested in the outcome of her appeal.  I congratulate her and her attorney, Donald Bruce Clark, on their victory. I couldn’t believe her business had any significant value, and the obvious injustice of making her pay her husband $301,500 for a one-half interest in a largely defunct company needed to be remedied.

In Herring-Wilson Wife ran a business, Jeanie’s Home Services, with Husband’s assistance. None of their clients had contracts with the business and, after the parties’ separation, each spouse took some of the clients and some of the clients stopped doing business with either spouse. Yet, at trial, Husband’s expert claimed the business had a discounted cash flow value of $603,000, and Husband claimed that Wife had kept control of the business. Meanwhile, Wife testified that the business’ value was the value of its equipment minus the business’ credit card debt.

There were numerous problems with the expert’s valuation. First, even the expert admitted this value was not what someone would be willing to pay for the business.  Second, the parties were taking a draw from the company but not counting it as salary. The discounted cash flow failed to account for this draw. Paying them each a salary of approximately $30,000 a year would have resulted in no positive cash flow. Third, by the time of trial, few of the customers who were with the company at the time of filing remained with the company: some had stopped doing business with either party and some had hired Husband in a competing business he established after the separation. Finally, at the time of trial, Husband had some of the business’ customers.  Thus valuing the business as though Wife had kept 100% ownership wasn’t accurate. Unfortunately Wife’s trial attorney failed to highlight these valuation problems and the Family Court adopted the expert’s valuation while awarding Wife 100% of the value of this now largely defunct business.  On appeal the Court of Appeals reversed and adopted Wife’s (minimal) valuation.

For very good reasons, South Carolina does not recognize personal goodwill in a business as subject to equitable distribution. As a self-employed attorney, I know my business has tremendous value to me (it is my means of livelihood) but has very little value to anyone who wanted to purchase it–unless that person is in the market for a used office equipment and furniture. Typically, personal services businesses only have the value of hard assets minus the hard debts (unless one is willing to devote labor after the sale to helping the new owners keep existing customers and maintain the business’ reputation–in which case part of sales price is the value is the owner’s post-sale labor and expertise). Valuing a personal services business as though the owner’s draw is pure profit grossly overvalues personal services businesses.

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