which way to go

Type of Matter:
A widow received a questionable offer to buy her departed husband’s business from his previous general partner. Questions arose and then litigation ensued.

A woman became a widow very suddenly and unexpectedly. Unfortunately, the aftermath of that tragic death added salt to the wound. Throughout the marriage, the husband maintained all the finances and investments. He was a sophisticated investor. Included in the portfolio of investments was a limited partnership interest in a mid-size business located and operating in another state. His wife knew nothing about the business, or partnerships, or the relationships with the other partners that died with her husband. In the midst of her grief, she barely grasped the concept that his partners had now become hers, along with all the rights and obligations of ownership.

The general partner saw an opportunity. He approached his new widowed partner and offered her a sum of money to buy out her limited partnership interest. He had obtained an “appraisal of the business” and used it as the basis to value the limited partnership interest. He observed the obvious distress and naivete of his new partner and pressed for a quick conclusion to the transaction. Fortunately, she sensed that there was something wrong. She contacted a law firm that did not understand her situation any better than she did. Fortunately, she switched law firms and, finally, had an advocate who saw the issue and understood the realities of her situation and the possibility of concluding the matter in a much more satisfactory manner.

Arxis Work:
The law firm, after preliminary discovery and inquiries, recognized that valuation assistance was needed. They forwarded to Arxis the “appraisal of the business” that was used as the basis for the initial buyout offer. Almost immediately, we noticed that the appraisal was for the land and buildings only. The appraisal was inadequate and, mostly, a waste of time and money. We immediately recognized that a valuation of a non-control limited partnership interest was needed – not an appraisal of some of the assets of the business. In short, it was not an appraisal of the business at all. The appraisal did not include several assets, the most material being intangible asset (goodwill) value.

We prepared a valuation of the limited partnership interest and the case settled on the eve of trial. The buy-out price ended up substantially higher than originally offered. From that standpoint it was a typical case with a normal ending. But the case highlighted several observations and recommendations to avoid and resolve similar litigation:

  • When a business interest is in dispute, an asset appraisal is, with some rare exception, not relevant or helpful. Appraisals tend to address tangible asset values but ignore intangible assets. Intangible assets are, for most businesses, the most important and valuable assets of the business. Ownership of a business interest includes the value of all the assets, and debt, of a business.
  • The partnership agreement in this case described the method and manner of valuing the partnership interest for a departing partner. The “buyer” tried to ignore it and the “seller” did not understand it. Both were a little disappointed with the results. The owners’ agreement, with some exception, will drive the valuation process for better or worse. It is advisable that business owners understand that agreement before trouble comes.
  • A “standard of value” is a set of assumptions that must be used to arrive at the value. Fair Market Value (FMV) is the standard of value that most everyone has heard of – and is least relevant in litigation involving owner/partner/shareholder disputes. When parties to a dispute retain a valuation/appraisal expert they often tell the professional that they want to know the fair market value. Rather, the attorney and valuation/appraisal expert should discuss the relevant standard of value and proceed on that basis. A lot of money is wasted on valuation and appraisal reports using the wrong assumptions.

A distressed seller makes for potentially bad deals. Any transaction involving an interest in a closely-held business should be concluded only after review by a professional that understands valuation.