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The key person discount · Family Law Talk

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  Speaker 1: Welcome to Family Law Talk. Familylaw Talk presented by Kirk
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  Stangy of Stangy Lawfirm PC. Stangy Law Firm is a
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  multi state family law firm. Now here's your host, Kirk Stangy.
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  Speaker 2: Welcome to Family Law Talk. We have an interesting topic today.
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  The topic is the key person discount and this episode
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  today is based on an article on our blog FAMI
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  Lawheadquarters dot com dated March fifth, twenty twenty six, and
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  the title of that article is Understanding the key person
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  discount and Business Valuation. So as a follow up to
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  the episode today, go on over to familaweadquarters dot com
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  and read this article from more information. But let's go
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  ahead and jump on into the topic at hand. The
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  reality is that any divorce case can be difficult and
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  can be challenging, but when you throw in a business valuation,
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  it can make it actually cumbersome. Okay. So, in some
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  divorce cases, one or both of the parties owns a
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  business of some kind, okay. And when that business is
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  owned by one or both of the parties, one of
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  the most important things that has to take place in
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  order to resolve the divorce is to value the business.
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  So what is the business worth is the critical question.
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  And in some cases one party buys the other party
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  out of the business, and other cases maybe the parties
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  sell the business and divide whatever the revenue is that
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  comes from the sale. In other cases, there could be
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  some sort of offset where one party keeps the business
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  and then the other party gets other assets that roughly
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  equal the value of the business itself. Okay, But at
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  the end of the day, you've got to value the business,
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  and when you get into business valuations, it is a
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  murky topic, and this is where it can be somewhat subjective. Okay.
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  There's three approaches devaluating a business. The first approach is
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  what's called the income approach, where a business valuator looks
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  at the income a company has generated over the course
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  of time and they create projections in terms of what
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  they think the business will do in the future, and
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  based on these projections, they then come up with a
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  value for the business itself. Okay. In other cases, business
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  valuators might use the market approach, and the market approach
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  is much like home sales, where you look at comparable
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  sales in terms of homes that are comparable to the homes.
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  The party may the parties may own. Let's say right,
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  and you look at these comparables and you say, okay,
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  on the market, this is what we think this home
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  would be worth. It's the same thing in business valuations.
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  If you can find similar businesses that were sold, then
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  you can look at these comparables. The problem with that
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  approach can be there aren't always comparable businesses in a
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  given market, especially if you get into niche areas of
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  businesses in the same time. With the income approach, the
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  downside to that approach is, look, it's hard to project
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  what a business is going to do in the future.
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  So just because a business made a certain amount of
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  income in the past, that doesn't mean they're going to
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  make that amount of income in the future. The other
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  approach to valuating businesses is the asset approach. So you
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  look at the value of the company's assets and you
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  valuate those to come up with the value for the business.
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  This works better where there's equipment, where there's supplies, maybe
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  a warehouse versus merchandise, and you can put a value
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  to that. But the downside of this approach some businesses
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  don't have a lot of assets, they don't have a
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  lot of equipment, they don't have a warehouse full of merchandise.
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  Maybe it's a professional services business or something like that,
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  and there's just no assets to even to value, okay.
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  And so look, business valuators go through these three different
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  approaches evaluating a business. In some cases, a business evaluator
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  will just simply look at one of the methods, and
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  a lot of cases a business valuator might give some
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  deference to all three of these approaches and then say
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  I primarily relied on the market approach or the income
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  approach or whatever. And obviously, business valuators also have to
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  be cognizant of case law and a certain jurisdiction. There
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  can be some some differences by states in terms of
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  what courts and certain jurisdictions want to see, and that
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  can make a difference there as well. But then there's
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  this concept of this key person discount, which is really
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  the topic at hand. Okay. A key person discount recognizes
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  situations where a business is heavily reliant on one particular individual, okay.
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  And the idea is is that if that individual were
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  no longer involved in the business, the business revenue might
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  drop significantly. And if that were to occur, the value
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  of the business would be a heck of a lot less. Okay.
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  So think small or closely held businesses where you have
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  a single loaner or an executive who drives much of
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  the company's success. Okay. That person might be responsible for
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  bringing in a majority of the clients or the customers.
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  They might be the individual who manages important relationships with customers,
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  with employees, and there may be the glue that holds
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  everything together. Key persons can be the individuals who oversee
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  operations of the business. They might even have specialized expertise
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  in certain areas of the business that could not be
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  easily replaced. Okay, So in these kinds of situations and
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  these kinds of cases, a key person discount can be
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  applied to the business. And this is particularly true where
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  the key person is one of the divorced litigants. Right.
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  So the idea is this is that, look, if that
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  divorced litigan could be a husband, could be wife, if
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  they were no longer in this business, there needs to
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  be a key person discount because that business value presumably
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  would drop without them, because they're the glue that holds
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  it all together. Okay, So a key person discount can
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  be a big issue in certain business valuations in a divorce. Okay,
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  and so again, this key person is responsible for generating
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  the company's revenue. They manage the key relationships, they oversee
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  the daily operations, and the idea is the company's value
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  would be significantly lower without them. When you get into
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  this discount though, there could be a big fact issue. Right.
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  One person might think a key person discount should apply.
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  So one of the divorced litigans should say, look, I'm
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  valuable to this company. Without me, this company would be
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  in trouble and there should be a key person discount.
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  The other divorce let again or the other spouse may
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  disagree with that and say, no, you're not that important.
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  You know, other people could be hired and brought in
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  and they could run the company equally as well without
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  your presence, and you're sort of overvaluating yourself. Okay, So
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  you can get into this big fact issue about whether
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  or not a key person discount should apply or not apply.
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  And in some divorce cases this can be a big
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  issue of dispute. And ultimately, when you get into the
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  application of the key person discount, this is going to
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  be heavily dependent upon the facts. Okay, So what courts
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  and valuators business valuators, I should say, should typically do
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  is really get into the granular into the company and
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  determine whether the customers or the clients primarily rely on
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  an individual owner or not. You know, and if that
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  individual owner were no longer part of the company, then
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  the question would be with the customers and the clients
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  keep coming or would they not keep coming without that
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  person being there? Okay? And other factors that, again that
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  are really important to look at, is not just servicing
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  of the clients or customers, because some business viouators can
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  go down this rabbit hole where they say, well this
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  CEO or business owner, they're not the ones really servicing
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  the clients or customers themselves. So if they're not the
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  ones actually doing it, then maybe a key person discount
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  shouldn't apply because they're not the ones right where the
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  rubber meets the road. They're not the ones servicing these clients,
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  so they're not that important, then they're not that valuable.
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  But other things that should really be looked at in
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  this analysis, and I think savvy business vouators look at
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  this is not it's not just servicing the clients or customers.
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  It also comes down to who's managing the business, and
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  is it this person who's purportedly the key person. They're
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  the ones who manage the business. And then you get
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  into an issue of who's working with the other employees
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  to make sure that they're doing their essential job functions. Okay,
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  And if it's this purported key person who's doing that
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  primarily and all these other employees are really looking to
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  this key person, then that would weigh pretty heavily in
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  favor of the one divorce litigant being a key person.
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  But if these employees aren't reliant on one of the
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  divorce litigants for their ability to do their own job,
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  then maybe a key person discount shouldn't apply. Other issues
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  you get into again is with the company's revenues in
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  relationships to client if this person were gone. So I mean,
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  take certain businesses where the customers and the clients are
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  coming primarily because you know this purported person is there
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  in the company, Okay. If the customers and the clients
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  wouldn't come without this key person, then that would weigh
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  heavily in favor of a key person discount being applied,
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  And the opposite would also be true. And again other
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  pieces to this is this concept of kind of the
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  specialized knowledge the expertise of the particular business owner. Okay,
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  if the particular business owner has particular specialized expertise in
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  terms of the business itself, in terms of the functions
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  of the business, and if they were gone, then the
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  rest of the company wouldn't have that person anymore to
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  rely on. Okay, that would weigh heavily in favor of
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  a key person discount. Let's say the purported key person
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  has strong knowledge of the company systems, maybe they developed them,
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  maybe they developed the management structures and it's pretty darn unique.
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  Maybe they're heavily involved in the marketing of the company
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  itself and they're really the only ones who know how
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  the marketing works, and they're the ones who develops the
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  strategy for the company itself. Then that would weigh much
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  more heavily in favor of a key person discount. On
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  the other hand, of how other managers could be brought
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  in or other marketing companies could be brought in and
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  they could do basically the same thing, and the person's
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  knowledge isn't that specialized, and that would weigh in favor
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  of no key person discount. Okay. Ultimately, if you're going
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  through a divorce and a business valuation is taking place
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  and this key person discount is a big issue in
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  the case, having an experienced business valuator matters, okay, So
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  make sure you're talking with your attorney and you've got
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  a business valuator who has experience with these types of issues. Okay,
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  this is really critical. If you don't have an experienced
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  business valuator, they might not know how to navigate the
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  issue of a key person and discount. Okay. Lots of
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  business valuators are going to look at the financial documents
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  of the business. They're going to look at the tax returns,
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  the profit laws statements, and these kinds of things. Okay,
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  I mean this is kind of basic things, but some
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  business valuators can kind of stop there. They want to
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  look at the financial documents, the tax returns, the p
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  and ls, these kinds of things, and then that's kind
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  of it. When you get to the issue of the
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  key person discount, it really requires more than that. Okay. Obviously,
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  business valuators are going to look at those financial documents
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  and they're going to need those. It's sure they're going
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  to rely on those and a lot of respects to
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  come up with the business valuation. But the best business
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  valuators who are able to deal with issues like keyperson discounts,
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  so they're actually going to take the time to try
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  to understand how the business functions, how clients are obtained,
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  how works performed within the company, who's actually driving the
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  company's success in right, So that's going to require interviews
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  of key people within the business itself, managers, employees, and
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  you know the question is going to be, is the
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  purport a key person actually a key person? Are they
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  the one actually driving the business, driving the success, driving
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  the innovation, driving the ideas, the strategy of the company itself.
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  And if the purport a key person is the one
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  who's doing that, that should weigh heavily in favor of
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  a key person discount. Even if they're the one who's
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  more a CEO kind of role and they're not servicing
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  the clients themselves, but they're still the one driving the
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  success of the business, a key person discount ought to apply. Okay,
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  business valuators who don't take the time to learn the
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  business itself, they just sort of hung up on the
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  spreadsheets and they never learn about the business itself. I mean,
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  they're not going to be in the best position to
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  understand whether a key person discount ought to apply or not.
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  And then you get into how much of a key
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  person discount, and then you start talking about math and
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  numbers and these kinds of things, and they're not going
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  to know what discount, what actual discount to apply or
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  not apply because they haven't taken the time to learn
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  the business itself. Okay, So look, in the end, business
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  valuation is very important in some divorce cases, particularly in
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  cases where one or both of the parties have an
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  interest in a business. And I would just say particularly
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  where they have a majority interest, but look, minority interests
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  can be valuable in some circumstances as well. But when
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  you get into the issue of a key person discount,
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  you want an experienced business valuator. And I would say,
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  particularly if you're a divorce litigant and you believe yourself
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  to be a key person, you're going to want to
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  experience business valuator and one who's not only going to
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  look at the financial documents, but one who's actually going
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  to learn about the business, learn the details of the business,
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  maybe put those spreadsheets in financial documents down for a
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  little litle bit and learn about the business and get
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  in the granular and only then can a business valuator
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  really truly come to determination about whether somebody is a
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  key person or not and whether a discount is warned
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  it or not. Okay, So that's the topic today. Definitely
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  an interesting one and kind of a granular one, but
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  one I wanted to cover because it can be important
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  in some divorce cases. Again, as a follow up to
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  the episode today, going over to familaweadquarters dot com, read
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  the article dated March fifth, twenty twenty six titled Understanding
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  the keyperson, discount and business valuations. Well, that's our topic today.
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  Thanks for tuning in and stay tuned to our next
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  episode of Family Law Talk coming up. Thank you very much.
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  Speaker 1: Thank you for listening to Family Law Talk with Kirk Stangy.
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  Visit Stangy Lawfirm dot com for more about today's topic
• 15:51
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