CT divorce: Valuation of minority shares of closely held businesses

Many people in Connecticut own shares of family businesses set up to keep the entity and its profits within the family unit. Sometimes closed corporations involve small groups of friends or acquaintances as the sole shareholders, restricting business ownership exclusively to them.

Family businesses in divorce

When the co-owner of a closely held company divorces, their ownership interest is normally a marital asset subject to equitable property distribution between the spouses. A closely held entity’s governing documents often direct that any transfer or sale of shares must be to the other members or back to the business itself – and sometimes they explicitly ban transfer to an ex-spouse.

So, instead of assigning any actual ownership rights to the other spouse, the court often determines the spouse-minority interest owner’s value, keeping ownership with the participating spouse and accounting for the asset’s value in the overall property division. This also makes practical sense as the outside spouse and the other shareholders likely do not desire to work together.

Valuation issues with minority interests

When the spouse-shareholder owns fewer than half the shares or less than half the value of the family business, they normally have less power over business decisions as a minority stockholder. Also, transferability of the shares to new owners may be severely restricted. As a result, the asset has little or no value to buyers on the open market.

Rather, the marketplace of potential purchasers likely consists only of other family members or co-owners of the closely held business. To reflect this severely limited market and diminishment in market value, Connecticut courts often discount the value when someone with a minority business interest divorces.

This “so-called ‘minority discount’ involves first establishing the full market value of a minority interest and then discounting that value by an appropriate percentage to account for such factors as nonmarketability of the shares and the minority interest holder’s inability to control management.” Siracusa v. Siracusa, 30 Conn.App. 560 (1993).

One judge noted that in valuing a minority interest in a business, deciding whether to apply a discount is an “integral part of the process of determining the value of those shares to a potential purchaser.” Curran v. Curran, 2016 WL 402444 (unpublished 2016).

For example, one court on remand applied a minority interest discount because the litigant had a noncontrolling interest, plus a second marketability discount for “lack of liquidity … in the open market … a minority interest in a business does not have a ready market and is more difficult to sell.” Brooks v. Brooks, 2012 WL 4377825 (unpublished 2012).

Court has discretion in valuation matters

The court’s valuation of a minority interest is a finding of fact that can vary in different circumstances. In divorce cases, Connecticut courts have wide discretion to choose the business valuation method (fair market value, liquidation, net asset, capitalization of earnings, or others) they feel is most accurate or equitable.

Still, the judge must “follow some reasonable path … [that is not] a patently erroneous methodology.” Brooks v. Brooks, 121 Conn.App. 659 (2010). A court may choose a method advanced by either litigant, the litigants’ positions, a combination of methods or the judge’s own valuation impressions, as long as the court does not “misappl[y], [overlook], or [give] a wrong or improper effect to any test or consideration which it was his duty to regard.” Turgeon v. Turgeon, 190 Conn. 269 (1983); see Antonucci v. Antonucci, 164 Conn.App. 95 (2016).

Impact of governing business documents is an issue in flux

The governing documents of a closely held company may contain a buy-sell or right-of-first-refusal provision that stipulates what happens to shares when a member divorces, retires or dies. Of course, this may limit the marketability of the shares of a minority interest owner. The agreement may also predetermine the value of a minority interest.

Whether a shareholder, partnership or other agreement binds the court in evaluation of minority interest values or other matters is an area of some disagreement among Connecticut courts. For example, a judge adopted the valuation logic of one party’s expert based on provisions in shareholder agreements, including a formula to determine value resulting in a value of zero. Kravetz v. Kravetz, 2004 WL 2663974 (unpublished 2004).

Another judge pushed back against being constrained by provisions in corporate or business agreements, writing that the litigant asserting that the court was bound by a shareholders’ agreement had “produced no authority to support the proposition that a family court’s broad allocative power can be limited by the provisions of a shareholders’ agreement.” The opinion notes that while the appellate court has said that considering a buy-sell agreement was proper, it did not say that trial courts could not weigh other evidence. Schecter v. Schecter, 1999 WL 34857 (unpublished 1999).

After all, many other factors can impact valuation of a litigant’s business share, including “future prospects … current market value, prior earnings, cash flow, depreciation, assets, book value, excess earnings, capitalization of earnings, projections of future cash flows and adjusted earnings.” Sitterly v. Sitterly, 1991 WL 139677 (unpublished 1991).

Should issues of the applicability of provisions in business agreements to a court’s valuation decisions arise, a sophisticated matrimonial lawyer can analyze the current state of the law on this matter to advocate for their client’s interests.

Minority discount inappropriate where only owners were the two spouses

In Siracusa where the only family business owners were the two divorcing litigants, the court declined to discount the value of the 40% minority interest. The judge ruled that an exception to the discount was appropriate because the family business was wholly owned by the two spouse-litigants and one of them would get the other’s share to become the sole owner. The minority discount applies more logically when one spouse has a minority interest and the other owners are outside third parties, reasoned the court.

Legal counsel imperative

An experienced and knowledgeable Connecticut family lawyer can assist in negotiating a stipulation to the value of a minority interest to avoid having to litigate the issue in the divorce trial, although the judge in narrow situations could reject the stipulated value. Or the parties could agree on an expert to conduct a valuation of the minority interest that both will accept. See Curran, 2016 WL 402444 (unpublished 2016).

The attorney can thoroughly investigate and use the discovery process to understand the nature of the minority interest, and curate and present to the court relevant evidence of value. This often requires the retention of experts to analyze the asset and potentially submit reports or testimony to the court.

If a litigant does not submit adequate valuation evidence, the judge may rely on the other litigant’s assertions or the judge’s own opinion or may order a neutral third-party expert to analyze it. Or, if neither litigant provides sufficient evidence of value, the court can place a value based on “scant evidence.” Bornemann v. Bornemann, 245 Conn. 508 (1998). A party’s failure to present sufficient valuation evidence of a minority interest may cause them to lose the opportunity to challenge the judge’s valuation findings later. McRae v. McRae, 129 Conn.App. 171 (2011).