ACC 5010 Module 6 Case Study: Valuing a Boatyard in a Divorce Example

What the Boatyard Is Worth: Valuing a Closely Held Business for Equitable Distribution

Student Name

Master of Science in Accounting, Thomas Edison State University

ACC-5010: Principles of Forensic Accounting

Mentor Name

Month Day, Year

What the Boatyard Is Worth: Valuing a Closely Held Business for Equitable Distribution

The Case

Hopatcong Marine Services, a composite business on Lake Hopatcong, stores about 400 boats over the winter and repairs engines and hulls year round. It is a corporation owned 100 percent by one spouse, who founded it during the marriage. The other spouse's attorney retained a forensic accountant to value the business as of the date the divorce complaint was filed. The yard reported pretax income of $310,000 last year, and the owner drew a salary of $260,000.

Question 1: What standard of value applies?

The standard of value determines what question the valuation answers. Tax cases usually ask for fair market value, the price an imaginary buyer and seller would agree on if both knew the facts and neither had to deal. Courts in divorce cases often apply a version of fair value, which seeks a fair result between the parties and may not apply discounts that a hypothetical buyer would demand. New Jersey courts value businesses for equitable distribution with an eye to fairness between spouses, and the premise of value is a going concern, since the owner intends to keep operating the yard (Crain et al., 2019). The valuation date also matters: here it is the filing date of the complaint, so growth the owner creates afterward through his own efforts generally belongs to him alone, and the expert should not build later results into the value.

Question 2: What are normalized earnings?

Reported earnings in a closely held company often reflect the owner's choices more than the business's economics. Normalization adjusts them to what a typical owner-operator would report.

Question 3: What is the value under the income approach?

The capitalization method turns a single year of expected earnings into a value by dividing it by a rate that reflects risk net of growth. The discount rate is built up from components: a risk-free rate of 4.5%, an equity risk premium of 5.5%, a size premium of 5.0% for a very small company and a company-specific premium of 6.0% for dependence on the owner, seasonal revenue and a single location, totaling 21%. Subtracting long-term growth of 3% gives a capitalization rate of 18%. Next year's expected earnings are $308,790 x 1.03 = $318,054, and the value is $318,054 / 0.18 = $1,766,967, or about $1,767,000.

Question 4: What does the market approach indicate?

Transactions in small marine service businesses compiled in private sale databases suggest prices around 4.5 times earnings before interest, taxes, depreciation and amortization. Normalized EBITDA is $423,000 of pretax income plus $60,000 of depreciation and $15,000 of interest, or $498,000. At 4.5 times, enterprise value is $2,241,000. Subtracting $300,000 of debt gives an equity value of $1,941,000. The market approach depends on how comparable the sample transactions are, and few involve lakefront yards with storage capacity this large.

Question 5: How should the values be reconciled?

The income approach receives more weight because it rests on the yard's own normalized results, while the market approach depends on transactions of uncertain comparability. The reconciled value is about $1.84 million.

Question 6: Should discounts apply, and how is goodwill treated?

A hypothetical buyer of a private company pays less than for a comparable public one because the shares cannot be sold quickly; Officer (2007) found that acquirers paid substantially less for unlisted targets than for comparable public ones, consistent with a discount for lack of liquidity. New Jersey's courts, however, have held that a marketability discount should ordinarily not be applied in equitable distribution when no sale is contemplated, absent extraordinary circumstances, as in Brown v. Brown (2002). Because the owner will keep the yard, no discount is applied here. On goodwill, New Jersey has treated the goodwill of a business built during the marriage as distributable property, a principle established for professional practices in Dugan v. Dugan (1983). Part of Hopatcong Marine's value reflects the owner's personal relationships with boat owners; the expert should explain whether and how that personal element is separated from enterprise goodwill under the law that applies.

Question 7: How should the expert report and defend the value?

The report should state the standard and premise of value, the valuation date, every document relied on, each normalization adjustment with its support, the derivation of the discount rate and the reasons for the weights given to each approach. It should present a sensitivity table showing how the value changes if the company-specific premium moves from 4% to 8% or growth from 2% to 4%, since opposing experts usually attack those two inputs. At trial, the owner's expert will likely argue for a lower value by treating more of the goodwill as personal, by raising the company-specific risk for the owner's central role and by citing the yard's dependence on one lake. The forensic accountant's defense is documentation: customer lists showing how many boat owners have stored there for more than five years, a manager capable of running daily operations and the published sources for each rate. A value that is transparent and reproducible is harder to discredit than one that is merely plausible.

References

Brown v. Brown, 348 N.J. Super. 466, 792 A.2d 463 (App. Div. 2002).

Crain, M. A., Hopwood, W. S., Gendler, R. S., Young, G. R., & Pacini, C. (2019). Essentials of forensic accounting (2nd ed.). John Wiley & Sons.

Dugan v. Dugan, 92 N.J. 423, 457 A.2d 1 (1983).

Officer, M. S. (2007). The price of corporate liquidity: Acquisition discounts for unlisted targets. Journal of Financial Economics, 83(3), 571-598. https://doi.org/10.1016/j.jfineco.2006.01.004