Hester v. Hester, 2022 Va. Cir.

Several issues were decided in this Virginia divorce case. Still, we focus on only two topics relevant to business valuation and equitable distribution: (1) the valuation of the husband’s 20% interest in an S corporation; and (2) the treatment of the PPP loan.

The court issued many findings dealing with the marital estate, divorce, and related matters. The first matter for our discussion is the valuation of the husband’s 20% interest in Eastern Virginia Ear, Nose, and Throat Specialists (EVENTS), an S corporation. The court noted the husband’s ownership interest and that half of the value of that interest would belong to the wife in the distribution of marital assets. EVENTS is a complete otolaryngology and head and neck surgery practice that five board-certified ENT physicians own and manage. During the pandemic, EVENTS’ business slowed for several months in 2020 but rebounded in 2021. 

Both parties’ experts used the same methodology to value the business, the income approach utilizing net cash flows. Both experts focused on the individual compensation and income stream instead of valuing EVENTS as a whole and then applying a pro-rata share to the husband. “According to the experts, this method best segregates practice or corporate goodwill—which represents the value of being an owner and is marital property—from Husband’s goodwill—which is not marital property.” Both experts agreed that the husband would retire at age 67 and receive a buyout of his practice interest of $10,000. The wife’s expert, David Timms, valued the stake at $1,341,000, while the husband’s expert, Holly Martin, valued it at $700,000. The experts also used similar capitalization rates. “The experts’ valuations differ significantly based on their assumptions and calculations regarding the “extended value,” or “excess earnings differential”—which represents the corporate goodwill—of Husband’s interest in EVENTS.”

Timms used a three-year weighted average, while Martin used a five-year unweighted average. While the court found Timms’ calculation persuasive, it disagreed with his use of the weighted most current three years. There were unique circumstances, including a partner’s retirement, the pandemic, and variable reimbursement rates. The court found that an unweighted most current three years is the better measure of future value. The court also uses a capitalization rate of 18.0% resulting in a court-derived value of $995,973. [Editor’s note: The court value was $25,000 less than the average of the two values the experts determined. Whether purposefully or not, this effect is a “splitting of the baby.”]

The court then discussed the disposition of the husband’s 20% interest in PPP loans, amounting to $172,820. Even though the court noted that the disposition of the PPP loans had not been determined at the trial date, the court decided the amount was “excess income” and credited the wife’s assets with one-half of the amount, or $86,410.