Legal Update: Kwak v. Bozarth
The Perils of a Party Doing their Own Business Valuation in a Dissolution Action
Kwak v. Bozarth is an unpublished Massachusetts case. The trial court made several decisions based on unavailable data. The case illustrates the perils of a party in a martial dissolution acting as their own expert and underscores the importance of how the standard of review affects an appellate panel’s review of the trial court decision.
Valuation professionals often say that valuing privately owned businesses is a blend of science and judgment. Kwak v. Bozarth, 2023 Mass. App. Unpub. LEXIS 179; 102 Mass. App. Ct. 1116; 2023 WL 2817904 (Mass. App. April 7, 2023) put that truism to the test. The sole issue on appeal in this divorce case was the value of Wife’s dental practice, and some data was unavailable, requiring a more flexible approach.
Background
Wife was the sole shareholder of a dental practice that provided, in addition to general dentistry services, prosthodontic services, which includes providing dentures, bridges, and implants. In a pretrial agreement, the parties determined that Husband would receive 25 percent of the fair market value of the practice as of June 2017. Only, the value of the practice remained in dispute.
At the trial, Husband proffered a valuation expert who presented a June 2017 value for the practice of approximately $2,000,000, based on a capitalization of earnings approach. Husband’s expert normalized 2015, 2016, and 2017 earnings, primarily adjusting for excess shareholder compensation. From that indication of value, the expert deducted 21 percent to account for Wife’s professional goodwill. According to the expert, Husband was entitled to $518,500.
Wife, on the other hand, testified to her personal opinion that the business was worth $662,452 (presumably entitling Husband to $165,113). Wife’s valuation methodology involved deducting business debt from 60 percent of average gross receipts.
The trial court wholly rejected Wife’s calculation, finding that it was not a recognized business valuation method and adopted, with one adjustment, Husband’s expert’s analysis. In her appeal, Wife challenged the trial court’s acceptance of the expert’s normalization adjustments of shareholder compensation and the allegedly random professional goodwill adjustment.
Court Findings
The value of a business is a factual issue. Generally, appellate courts may not “disturb the judge’s findings of fact unless they are clearly erroneous.”[1] A clearly erroneous finding must involve more than a factual dispute between two witnesses since the trial court, in sitting as fact finder, is entitled to weigh the credibility of the witnesses and accept the testimony of one over another.
Compensation Normalization Adjustments
The valuation expert concluded that the company paid Wife more than the market compensation in 2015, 2016, and 2017. He based his analysis on a review of dentist salaries on the Indeed.com and Salary.com websites. The expert acknowledged that (a) the data was insufficient to distinguish between regular dental salaries and the compensation for a prosthodontist and (b) that he did not locate any prosthodontist specific compensation from, for example, professional associations or the U.S. Bureau of Labor Statistics.
Wife testified that her compensation was not excessive because, according to her, the industry standard was to pay prosthodontists up to 50 percent of their collections. She argued on appeal that her testimony was uncontested, but as the appellate court found, the trial court was under no obligation to find her testimony credible even if Husband did not present evidence showing it to be wrong.
Ultimately, the trial court accepted the expert’s adjustments for 2015 and 2016, but determined that the 2017 adjustment, calculated the same way as the prior years, was not supported. The trial court apparently did not explain in detail why it found that the adjustments for 2015 and 2016 were acceptable and the 2017 adjustment was not. The appellate court theorized:[2]
Based on this testimony, the judge could reasonably infer that [the expert’s] inability to differentiate between average salaries for dentists and prosthodontists did not render the 2015 and 2016 adjustments unreliable because (1) the wife, and the practice as a whole, performed less prosthodontic work in those years; and (2) those years were given substantially less weight in [the expert’s] calculation of cash flow. Likewise, the judge could permissibly conclude that [the expert’s] use of a salary adjustment for 2017 based on a dentist’s, rather than a prosthodontist’s, salary was unreliable because the wife and the practice overall were doing more prosthodontic work in 2017, which was the most predictive and heavily weighted year in [the expert’s] cash flow calculation.
Regardless of what may have driven the trial judge’s decision, there was no “clear error” in the resulting analysis.
Professional Goodwill
On appeal, Wife also challenged the expert’s adjustment for her professional goodwill, arguing that he had “randomly pegged” it at 21 percent, which she contended was “nothing more than a guess.” Wife concluded that the expert had, therefore, overvalued the business. She argued that the only method for calculating professional goodwill was to use the percentage of revenue generated by her patients, but she provided no authority for that to be the only acceptable method.
At trial, the expert testified that he based the 21 percent adjustment for professional goodwill on the difference between the value determined from capitalizing cash flow and “the value of the practice using an alternative valuation methodology derived from multiplying the practice’s 2017 adjusted pre-tax income by the average EBIDA [sic] multiple for dental practices.”[3] The expert further testified that this result was consistent with Wife’s testimony that she generated approximately 40 percent of total revenues and that it was reasonable to assume that half of her patients would no longer visit the practice if she left.
The expert did however acknowledge that one would normally review the client base to assess which patients had specifically sought out Wife’s services and might not use the practice if she were not there. Professional goodwill would be based on the revenues attributable to those patients. The expert testified that he had specifically requested a list of Wife’s patients and the revenues collected from them, but Wife had failed to provide the requested data. Given that failure to comply with the request, the expert had utilized an alternative methodology to estimate the result. The appellate court refused to find fault with the trial court’s acceptance of this estimate particularly considering Wife’s failure to provide the data required to do the calculations she insisted were necessary.
Conclusion
This case is an object lesson in the importance of providing expert analysis and testimony in business valuation. It also shows that there is no single way to calculate the value of a business and that, sometimes, estimates must be made based on the available data.
[1] 2023 Mass. App. Unpub. LEXIS 179 at *2.
[2] Ibid. at *6.
[3] Ibid. at *10.
Michael J. Molder, JD, CPA, CFE, CVA, MAFF, applies 30 years of experience as a Certified Public Accountant and litigator to help investigate and analyze cases with complex financial and economic implications. He has acted as both counsel and accounting expert in pending and threatened litigation as well as participating in internal investigations of financial misconduct. As a litigator, Mr. Molder helped co-counsel understand complex financial and accounting issues in dozens of cases. In 2006, Mr. Molder returned to public accounting applying his unique skills to forensic engagements. He has also performed valuations of business interests in a wide variety of industries.
Mr. Molder has served as valuation expert for both plaintiffs and defendants in commercial litigation matters and owner and non-owner spouses in matrimonial dissolutions. He has participated in the valuations of businesses in a wide variety of industries, including: food service, wholesale and retail distribution, literary development and production, healthcare, manufacturing, and real estate development.
Mr. Molder has also investigated and valued damages in a wide variety of litigation contexts ranging from breach of contract claims to personal injury cases, and from employment disputes to civil fraud. He has consulted on many matters which have not involved the issuance of a report for litigation or resulted in deposition or trial testimony. Accordingly, the identity of these matters is protected by attorney client privilege.
Mr. Molder has also lectured widely on a variety of accounting and litigation related topics including business valuation, financial investigations in divorce proceedings, accountant ethics, financial statement manipulation and “earnings management.”
Mr. Molder can be contacted at (610) 208-3169 or by e-mail to Molder@lawandaccounting.com.
