Personal Goodwill Can Have a Big Impact on Fair Market Value
When WADL-TV 38 founder Franklin Z. Adell died, he left behind what would prove to be a complex estate. The estate, handled mostly by Adell’s son Kevin, isn’t a stranger to legal battles. In the years since Adell’s death, the heirs have faced a number of legal issues, including a dispute between Kevin and his two sisters regarding distribution of assets from the estate.
This is a bellwether case on personal goodwill and its impact on fair market value of a business. Is it worth $92 million dollars like the IRS’ initial estimate or $4.3 million dollars liquidation value as opined to in the estate’s second valuation?
This is the range of the valuation opinions on this case. The key takeaway in all of this?
Make sure your appraiser understands all key agreements because they can be critical to the value proposition.
The facts of the case are as follows: A religious non-profit corporation (The Word Network) transferred virtually all their revenues via a service agreement to a for-profit entity (STN.com, Inc.) owned 100% by Franklin Adell. This was the only customer of STN.com. Mr. Adell’s son Kevin was very active in the company and also had strong personal relationships with the trustees of the non-profit. He had no non-compete or employment agreement with the STN.com.
After his father’s death, Kevin Adell, formed a mirror corporation and all the employees but one, moved to a new corporation as did the service agreement from the Word Network and its associated revenues.
The IRS’ initial valuation assessment was $92 million dollars for the enterprise of STN.com. A national appraisal firm’s expert appraiser’s, hired by the Estate of Mr. Adell, initial assessment was $9.3 million. In this valuation, consideration was given to the personal goodwill of the son, Kevin Adell. The estate’s appraiser believed there was significant inherent risks associated with Kevin’s personal goodwill for the business which warranted a substantial discount.
In a subsequent valuation by the estate’s appraiser, he concluded that he had not fully considered the restrictive terms of the service agreement with the non-profit. In this reevaluation he concluded that a valuation of STN.com, Inc. was $4.3 million dollars. To arrive at this conclusion, he used the adjusted book value and gave no market value for intangible assets. The IRS’ expert adjusted the initial assessment of $92 million and testified that the value was $26.3 million dollars at the date of death.
The judge found that the estate’s substantially inconsistent positions regarding the valuation and therefore the burden of proof remained with the estate. Since STN was historically profitable and an economic charge of $8 to $12 million dollars for Kevin’s personal goodwill was deducted from the valuation in the first appraisal, the court concluded that the first appraisal from the estate’s expert was reasonable and selected $9.3 million dollars for the fair market value.
In summary, performing valuations for estate tax purposes is a serious matter as the audience for these reports is the IRS which will challenge an opinion of value where the facts are not clearly communicated and risk is not adequately disclosed. In the above case, an IRS challenge resulted in a trial and multiple valuations.
This is an expensive by-product of not understanding the facts of the case at the outset. An attorney and their appraiser need to fully understand the facts and key agreements driving a business in the initial phases of an engagement. This case was not unique in its complexity. The concept of personal goodwill is logical and supportable, and the valuation implications are real. The valuation impact can be significant on fair market value.
This article was originally published in Valuation Viewpoint, September 2014.