Appellate court favors “rule of thumb” in business value dispute
Multiples or comparables?
In making their calculations, business valuation experts often are expected to rely, at least in part, on the value of comparable entities. But in a recent case, In re Marriage of Bauer, the California Court of Appeals allowed a business valuation based on “rules of thumb” multiples, rather than comparables. Not only did the court allow such an approach, but it increased the expert’s multiplier by more than 100%.
Wrestling over value
A licensed physical therapist, Randall Bauer co-owns a practice that employs several other physical therapists. When, after 16 years of marriage, Randall’s wife Rebecca filed for divorce, the spouses hired a forensic accountant, S.M. Zamucen, to prepare a written valuation of the business.
When the case went to trial, the court heard testimony from Randall’s former partner in the physical therapy practice as well as from Rebecca’s accounting expert. The court valued the business at about $1 million and awarded Rebecca $256,484 — half of Randall’s share.
But Randall contested the ruling, claiming, among other things, that the court’s valuation of his business was inaccurate. He pointed out that the accountant, Zamucen, valued the practice at between $450,000 and $547,000.
Factoring in positive attributes
The trial court supported its valuation decision with a two-page report that cited a publication quoted in Zamucen’s report, Business Reference Guide: The Essential Guide to Pricing a Business. This guide provides, as a rule of thumb for valuing physical therapy businesses, a multiplier of 60% to 100% of annual collected fees.
Zamucen had applied a 42% multiplier. But the trial court applied a multiplier of 100% to the business’s average gross profit of about $1 million for the four years preceding the marriage’s dissolution.
The trial court noted that the business had several factors in its favor, including a good location, long existence, reputable name in the medical community, established core of professional employees, history of income growth and recurring business. In addition, its owners were “hands on.”
Based on these many positive attributes, the trial court determined that a 100% multiplier was appropriate.
The appellate court agreed that the trial court had used a legitimate valuation method. It pointed out that Randall’s former partner had testified that the value of a physical therapy practice ranges from 1 to 2.5 times its gross annual sales. The partner also testified that the higher multiple is used if the business has existed for a long time. The appellate court found that his methodology mirrored the one described in the Business Reference Guide and used by the trial court.
Rebecca’s expert witness also provided testimony supporting the court’s valuation. The accountant used a market comparables approach which considered 31 other physical therapy practices that were for sale. The average listing price for these practices was 106% of their gross income. Accordingly, the expert concluded that the appropriate multiplier for Randall’s business would be 1 times its gross income.
The appellate court agreed with Rebecca’s expert, ruling that the trial court could calculate the value of Randall’s practice using the guide’s rule of thumb. All of the relevant witnesses supported a 100% multiplier, citing various marketability factors and the business’s health. Therefore, the court’s use was “well within the range of evidence presented.”
The value of supporting evidence
The Bauer court referred to the market comparables approach, but it was only to support the value derived from applying the Business Reference Guide’s rule of thumb. It’s possible that, when similar supporting evidence is offered, more courts will accept valuations based on multiples rather than comparables.