Soshnick: The asset approach in divorce valuations: How low can you go?

In July 2023 and January 2024, we assessed the income and market approaches to business valuations in divorce cases. That leaves for assessment the third business valuation approach – the asset approach – that valuation analysts are required to consider, but not apply, in valuation engagements.

Unlike the income and market approaches, the asset approach is rarely applied to functioning businesses. That approach and its underlying methods frequently correspond with “net book value,” or a lower conclusion of value than yielded under the income or market approaches.

One of the reasons asset approach conclusions of value generally are lower is that “net book value” is the difference between total assets (net of accumulated depreciation, depletion and amortization) and total liabilities as they appear on the balance sheet (synonymous with shareholder’s equity).

That simple balance sheet analysis does not fully capture potential goodwill or other intangible value and may not apply a “going concern” (ongoing operating business) premise of value. As a result, any conclusion of value under the asset approach may not apply the “fair market value” standard of value that is to be applied in Indiana divorce cases.

Valuation analysts in Indiana divorce cases must consider three valuation approaches: asset, income and market.

While all three approaches must be considered, the valuation analyst applies only the approach or approaches appropriate for the valuation engagement.

The “asset approach” is defined in the International Glossary of Business Valuation Terms as a general way of determining a value indication of a business, business ownership interest, security or intangible asset by using one or more methods based on the value of assets net of liabilities.

This approach is synonymous with the cost approach and most frequently applies the “adjusted net asset method,” which considers, as appropriate, the assets, liabilities and applicable liquidation costs.

When using methods under the asset approach, the valuation analyst should consider the type of cost to be used (for example, reproduction cost or replacement cost), the appropriate forms of depreciation and obsolescence, and the remaining useful life of the intangible asset.

Logic suggests that a net book value conclusion of the value of a professional practice or business will be at the lower, if not lowest, end of the valuation spectrum and may not represent the fair market value of a going concern.

Does Indiana divorce case law share that lack of preference for use of the asset approach in divorce cases?

The Indiana Court of Appeals indirectly considered the asset approach in a professional practice context in Peddycord v. Peddycord (1985). In valuing a law practice, the trial court used the benefits the wife would have received had the husband died at the date of filing of the divorce case.

The Court of Appeals reversed, holding that the law partnership interest was to be valued as if the husband had withdrawn from the partnership at the date of filing and noting that the trial court on remand was to decide whether to apply the formula for a competing or non-competing former partner. In either instance, the application of the partnership agreement formula would have resulted in lower values than under the income or market approaches and parroted an asset-based valuation.

In Porter v. Porter (1988), the Indiana Court of Appeals disapproved of Peddycord, held that all of a professional practice’s intangible goodwill value is marital property, and affirmed the trial court’s compromise value of a medical practice value well in excess of net book value. Although Yoon v. Yoon (1999) disapproved of Porter’s inclusion of personal goodwill as a marital asset, the Indiana Supreme Court made clear that enterprise intangible value is marital property for both professional practices and businesses. Notably, Yoon, like Porter, did not endorse the application of the asset approach to divorce valuations.

The asset approach made a brief, subtle comeback in Del Priore v. Del Priore (2016), in which the Indiana Court of Appeals affirmed the trial court’s valuation of the husband’s 50% membership unit interest in a record label that had one musical artist at the value of the husband’s shareholder loan to the business. This conclusion of value mirrored book value in the context of an entity with a limited customer base.

Most recently, Adewopo v. Jaja (2022) involved competing valuation analysts’ testimony in which the husband’s analyst applied the income approach while the wife’s expert applied the asset approach to value the wife’s businesses. The Indiana Court of Appeals affirmed the trial court’s adoption of the husband’s analyst’s valuation, which included enterprise goodwill. The Court of Appeals cited Yoon and noted that the wife failed to present evidence as to the presence or lack of enterprise goodwill – an issue inherent in the application of only the asset approach to valuation.

Given the lineage of Indiana case law and the pronouncement of Yoon, Indiana divorce courts give limited, if any, weight to the asset approach to valuation. While having some vitality in assessing the value of stagnant or failing professional practices and businesses, the asset approach does not adequately account for intangible value – causing it to run afoul of Yoon.

How low can you go in divorce valuations? Too low in most circumstances where the asset approach is applied.•

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Drew Soshnick is a partner in the Indianapolis office of Faegre Drinker Biddle & Reath LLP. Opinions expressed are those of the author.