Classic Case of Expert v. Expert Won by Attention to Intangibles, Discounts
Business Valuation Advisor, Spring 2007

Keener v. Keener, 2006 Iowa App. LEXIS 659 (June 28, 2006)

The Keener couple got married the day after incorporating their business, Alpha International, Inc., a toy manufacturer and seller. Over the next ten years, the husband acted as “the primary management force” and the wife was the sole shareholder, her consent required for all financial decisions. The toy company flourished, acquiring manufacturing equipment as well as sale rights to several notable toy brands. When they divorced in 2002, the wife received the business in her apportionment of the estate, apparently without notable disagreement. But the valuation of the company came down to a “classic battle of the expert witnesses,” according to the appeals court, with a several million dollar disparity in their competing reports.

Wife’s expert ignores intangibles

The wife’s expert issued an initial report valuing the company at $9.035 million. He used an asset approach, including a 15 percent discount for lack of marketability (DLOM) of the closely held corporation. He valued the company as a going concern, assuming that it would remain in operation, but he assigned zero value to the intangible assets (intellectual property rights, etc.) because, according to his testimony, they produced no positive cash flow.

Six months after his original report, this same expert reduced the valuation by $937,000, to account for possible litigation to defend against infringement of intellectual property rights in one of the major toy lines. He reduced the value further by the sum of $2.89 million “to book” a contingent liability (another lawsuit where a settlement was pending, but no final agreement had been reached). Due to the perceived high level of litigation risks, he also increased the DLOM from 15 percent to 30 percent, for a final amended valuation of $4.750 million.

Husband’s expert reads the footnotes

However, a footnote in the wife’s expert’s initial report stated that management viewed the pending litigation as “ordinary routine matters incidental to the normal business…not expected to have a material adverse effect on the Company’s consolidated financial position, results of operations, or cash flows.” Accordingly, the husband’s expert argued that the wife’s 30 percent discount was excessive. The better approach, he said, was to reduce the overall value by 5 percent to 10 percent and book the contingent and speculative liabilities. His net asset valuation of the company came to approximately $10.170 million.

The husband’s expert also disagreed with the zero valuation of the intangibles in light of the company’s recent sale of two name brands for $7.7 million and the pending (post-divorce) sale of a third brand for another $7 million. Although he had not received the relevant financial documentation and so could not issue a firm opinion, the expert estimated the rights to “hundreds” of other brand names would add another $20 million to $30 million of intangible asset value, increasing the company’s overall net worth to the $30 million to $40 million range.

Court agrees with valuing intangibles

The trial court wasn’t persuaded by the wife’s expert’s valuation, in part for its failure to value the intangibles and also for its “speculative” discounts concerning marketability and contingent liabilities. It found the husband’s expert’s report more credible, adopting his net asset value of $10.170 million and finding that the company’s intangibles were worth an additional $5 million. On review, the appeals court confirmed this, finding that the “undisputed” evidence of name-brand sales supported the intangible valuation.