LAM & JUNG
[2019] FCCA 388
•22 February 2019
FEDERAL CIRCUIT COURT OF AUSTRALIA
| LAM & JUNG | [2019] FCCA 388 |
| Catchwords: FAMILY LAW – Property – the Wife’s application for a division of the parties’ pool of assets – the value of the Husband’s business is not agreed – the parties have engaged three expert valuers to value the business – hearing to determine which of the competing valuations should be accepted as the proper value of the business. HELD –The proper value of the Husband’s business found to be $640,582. |
| Applicant: | MS LAM |
| Respondent: | MR JUNG |
| File Number: | MLC 8509 of 2017 |
| Judgment of: | Judge Bender |
| Hearing date: | 3 December 2018 |
| Date of Last Submission: | 3 December 2018 |
‘
| Delivered at: | Melbourne |
| Delivered on: | 22 February 2019 |
REPRESENTATION
| Counsel for the Applicant: | Mr Tatarka |
| Solicitors for the Applicant: | Mathews Family Law |
| Counsel for the Respondent: | Mr Williams |
| Solicitors for the Respondent: | Interise Legal |
ORDERS
No orders made.
IT IS NOTED that publication of this judgment under the pseudonym Lam & Jung is approved pursuant to s.121(9)(g) of the Family Law Act 1975 (Cth).
| FEDERAL CIRCUIT COURT OF AUSTRALIA AT MELBOURNE |
MLC 8509 of 2017
| MS LAM |
Applicant
And
| MR JUNG |
Respondent
REASONS FOR JUDGMENT
Introduction
This is a property matter listed for final hearing before Judge Riethmuller.
The parties have been unable to agree on the value of the Husband’s business.
On 4 October 2019, Judge Riethmuller made orders listing the discrete issue of the value of the Husband’s business on a date to be fixed for hearing with priority. By way of correspondence sent from the Chambers of Judge Riethmuller on 5 October 2019, the parties were advised the matter had been listed on 3 December 2018 with priority for the hearing of the evidence of the expert witnesses.
Due to Judge Riethmuller’s unavailability on 3 December 2018, the discrete issue of the value of the Husband’s business was heard by me.
Prior to the experts being heard, the parties agreed that the issue of how to treat the debts of the parties, including any business debts, would be determined at the final hearing before Judge Riethmuller and was not a factor to be taken into account when determining the value of the Husband’s business.
Background
On 21 September 2017, the parties jointly instructed Accountants Proprietary Limited (“Accountants”) to provide a valuation of the proprietorship of the business operated by the Husband and the business trust.
Accountants valuation, signed by Mr A and Mr B, directors and senior consultants of Accountants, was provided to the parties on 15 November 2017. Accountants valued the Husband’s business at $710,389 as at 30 June 2017.
On 9 March 2018, the Wife engaged Mr C, director in charge of forensic accounting services for Forensic Accountants Pty Ltd trading as Forensic Accountants (“Mr C”), to prepare a critique of the Accountants report dated 15 November 2017 and to provide an opinion of the value of the Husband’s business as at 30 June 2017. Mr C released his report containing his critique of the Accountants report and opinion of the value of the Husband’s business on 11 May 2017. Mr C valued the Husband’s business at $937,908 as at 30 June 2017.
Mr A swore an affidavit on 23 May 2018 adopting the Accountants report of 15 November 2017.
On 21 May 2018, Mr C swore an affidavit adopting his report of 11 May 2017.
On 23 August 2018, the Husband engaged Mr D, the director of Chartered Accountants Pty Ltd (“Mr D”) to:
a)consider and provide a report on the appropriate methodology (between the Accountants valuation and Forensic Accountants valuation) for the business valuation assignment as a family law matter; and
b)undertake a shadow valuation using the most appropriate methodology as well as providing a valuation using the alternative methodology.
On 18 September 2018, the Husband solely engaged Accountants to provide an update to their 15 November 2017 valuation report. On 3 October 2018, Mr A swore an affidavit annexing his updated valuation report dated 21 September 2018. Mr A valued the Husband’s business as at 30 June 2018 at $422,464.
On 27 September 2018, Mr D swore an affidavit annexing his report dated 26 September 2018. Mr D valued the Husband’s business at $640,582 as at 30 June 2018.
On 27 September 2018 the Wife engaged Mr C to:
a)prepare a critique of the Forensic Accountants report dated 26 September 2018; and
b)provide an opinion as to the value of the business as at 30 June 2018.
Mr C swore an affidavit on 4 October 2018 to which he annexed his report dated 2 October 2018. Mr C valued the Husband’s business as at 30 June 2018 at $1,052,302.
The Husband swore an affidavit on 21 November 2018 in response to Mr C’s report of 2 October 2018. In his affidavit, the Husband challenged Mr C’s calculation of his available work hours on the basis that:
a)Mr C failed to take into consideration the Husband’s care arrangements for the parties’ children pursuant to the existing parenting orders;
b)Mr C made no allowance for compulsory continuing professional development (“CPD”) and sick leave, noting the Husband had recently broken his finger which prevented him from working; and
c)Mr C failed to consider that the Husband is now solely responsible for attending to the management of the business.
The Wife engaged Mr C to prepare a revised valuation of the Husband’s business taking into account the Husband’s affidavit sworn 21 November 2018.
On 30 November 2018, Mr C swore an affidavit to which he annexed his report of 21 November 2018. Mr C revised his valuation of the Husband’s business as at 30 June 2018 to $856,513.
On 29 November 2018, Mr D forwarded an email to the Husband’s solicitor. In it he stated he had reviewed the most recent valuations from Mr A and Mr C and disagreed with both. He confirmed his valuation of 26 September 2018.
On 3 December 2018, Mr A, Mr C and Mr D gave vice voce evidence as to the various reports prepared by each of them and each other in respect to the value of the Husband’s business.
The Evidence
Accountant / Mr A
Valuation dated 15 November 2018 (“the first valuation”)
Whilst Mr A swore an affidavit on 21 May 2018 in which he stated “I completed my report on 15 November 2017. Annexed hereto and marked “-1” is a true copy of my report dated 15 November 2017”, when giving his vive voce evidence Mr A advised the Court the report of 15 November 2017 was actually prepared by his partner Mr B but that he had “checked his (Mr B’s) basic arithmetic”.
The basis of the first valuation was “fair market value” which is defined as:
“The price, expressed in terms of cash equivalents, at which property would change hands between a hypothetical willing and able buyer and a hypothetical willing and able seller, acting at arm’s length in an open and unrestricted market, when neither is under compulsion to buy or sell and when both have reasonable knowledge of the relevant facts.”
The Business Gross Fees for the Husband’s business were listed to be:
2014 $852,152 2015 $901,703 2016 $874,087 2017 $1,012,167
The maintainable fee base was determined by taking the average of the gross fees earned for the three years to 30 June 2017. The average was $929,319 per annum.
The Business Earnings Before Depreciation, Interest and Taxes (“BEBDIT”) was calculated utilising the 2016 full year accounts. BEBDIT was calculated to be $560,615.
Because the fee income had increased since 2016 an adjusted Maintainable BEBDIT was calculated to be $596,039.
Having determined the BEBDIT, the valuation then considered Opportunity Costs Business Salaries, being “what would be the true cost of the professional business staff, if all professional staff were employed on a totally arm’s length commercial basis.”
The valuation calculated the Opportunity Cost of the business on the basis that medical professionals are renumerated based on a typical business formula of gross fees minus laboratory costs multiplied by 40%. Based on maintainable fees of $929,319 this figure was $364,904.
The Earnings Before Depreciation Interest and Taxes (“EBDIT”) was then calculated by taking the Opportunity Cost from the Maintainable gross fee. Thus the EBDIT was calculated as follows:
Maintainable Fees: $596,039
less Opportunity Cost of business staffing: $364,904
Maintainable EBDIT: $231,135.
The EBDIT was then capitalised to arrive at a value of proprietorship of the business overall.
The valuation stated the capitalisation rate is affected by location, type, the market, entry costs and occupancy.
The factors of relevance to the capitalisation rate for the Husband’s business were noted as:
·the business operates at above average profitability due to its mix of procedures and good pricing;
·the area in which the business is located has above average income;
·there are high levels of businesses nearby making the business’ market position neither strong nor weak;
·the business catchment has a high level of Chinese ethnicity and the Husband’s language skills are a key element in attracting clients. This may however reduce the pool of potential purchasers;
·the business has a high level (65%) of clients utilising private health insurance. This high reliance represents a less attractive client base than a purely private client base without attachment to a health fund as the business may be adversely impacted by a change in health fund policy;
·the business would not attract a corporate buyer because of fees at the lower end of the range, the property lease position and the demographic of the clientele.
The capitalisation rate was therefore assessed at 35%, which indicated a proprietorship value of $660,385 before further adjustments.
The valuation stated:
Valuation of proprietorship
=
Goodwill
+
Equipment used in undertaking the business
The Equipment and rental adjustments were calculated to be $50,004. Thus the value of the Husband’s business as at 30 June 2017 contained in the first valuation was $710,389 (this equalled a capitalisation rate of 3.07).
Valuation dated 21 September 2018 (“the second valuation”)
The second valuation was undertaken by Mr A.
The basis of the valuation was again “fair market value”.
The gross fees of the business were listed as:
2014 $852,152 2015 $901,703 2016 $874,087 2017 $1,012,167 2018
$833,546
It was noted that the 2018 fees were lower than the previous four years. This was attributed to:
·the overabundance of medical professionals and businesses meaning almost universally, medical professionals are experiencing gaps in their appointments;
·in the specific case of the Husband, nearby areas such as Suburb L, Suburb M and Suburb N are saturated with businesses and another Mandarin speaking business purchased a business nearby;
·the decrepit appearance of the business which would deter potential clients when there are numerous other well-presented businesses nearby; and
·the lack of a guarantee of long term occupancy.
Mr A therefore did not take the average of the business fees for the three years to 2018 to calculate the Maintainable Fee Base, as was the methodology used for the first valuation. He used the 2018 figures only.
Mr A calculated the BEBDIT as follows:
Husband Taxable income $177,049 Interest expense $4,556 Motor vehicle expense $3,300 $184,905 Business Trust Depreciation issues $18,012 Interest received -$83 Accounting fee adjustment $19,881 Interest paid $30,177 Net profit $145,461 $213,448 Sub total $398,353 Plus contractual fees retained by other medical professionals $137,924 BEBDIT $536,277
The Business Opportunity Costs (“BOC”) calculated on the typical professional formula of gross fees minus laboratory costs multiplied by 40% for the Husband and his employed contracted employees for 2018 was $325,045.
The EBDIT, being BEBDIT minus BOC was calculated to be:
Maintainable BEBDIT: $536,277
less BOC: $325,045
EBDIT: $211,232.
In determining the capitalisation rate, Mr A considered the following factors:
·the business is operating at above average profitability per dollar of fee because of cost control. However, the fees have passed their zenith and overall are disappointing as they are well below the typical average privately owned business in Australia which “we estimate to have a fee base of $1.3 million”;
·the business is located in an area of above average income but there are high levels of competition nearby;
·the business catchment has a high level of Chinese ethnicity and the Husband’s language skills are a key element in attracting clients, but this may reduce the pool of potential purchasers;
·the business has a high level (65%) of clients utilising private health insurance as a part payment mechanism;
·a buyer seeking finance to purchase this business in decrepit premises without possibly having guarantee of long term occupancy may struggle to get finance;
·not attractive to a corporate group purchaser;
·the decrepit state of the premises requires substantial capital expenditure – estimated at $250,000;
·the high rent paid for the dilapidated premises; and
·no guarantee of long term occupancy.
Mr A expressed the view that:
“It is likely that the only substantial interest that would be shown would be by other businesses in the area hoping to buy his client list and telephone contact details at an appropriately discounted rate to augment their own existing fees. There is negligible value in second hand equipment if any and it is difficult to imagine any business buyer of our acquaintance actually being interested in purchasing this business.”
Because of all these factors, the capitalisation rate was assessed at 50% (or 2) and the value of the business was therefore assessed to be $422,464 as at 30 June 2018.
Mr A expressed the view that the value to owner concept that was used by Mr C and Mr D is an inadequate substitute for a business valuation assuming a business to business sale. He expressed the view that because of the severe impediment to the sale of the Husband’s business arising from the very poor condition of the premises and the lack of guarantee of occupancy, it matters little what valuation concept is used.
When giving his vive voce evidence, Mr A was highly dismissive of Mr C’s valuations, criticising him for:
a)not properly doing his research, by failing to read the Accountants website which, according to Mr A, contains all relevant information on businesses in Australia;
b)not applying the correct methodology in determining the Husband’s remuneration dispute, Mr C subsequently adopting the “40% of gross fees minus laboratory costs” as used by Mr A; and
c)not visiting the premises to see for himself their dilapidated condition.
It was Mr A’s evidence that Accountants first valuation was totally incorrect and should be completely disregarded. This is primarily because he (and presumably Mr B) had not seen the condition of the premises and what he describes as their dilapidated and run down state when the first valuation was prepared.
Mr A dismissed the proposition that the reduction in fees earned by the business between 2017 and 2018 was because the Husband had considerably reduced his working hours in 2018. It was his evidence that contract medical professionals would have been able to cover the hours no longer worked by the Husband. It is Mr A’s evidence that the contract medical professionals not picking up the hours no longer worked by the Husband is indicative of a decline in the business earnings and is not attributable to clients only being prepared to see the Husband and those clients taking their business elsewhere when the Husband was not available.
It is Mr A’s evidence that the differences between his second valuation and that of Mr D are not great as they agree on substantial issues, particularly the applicable EBIT to be used in calculating the value. The $200,000 difference in their valuations comes from the different capitalisation rate applied by them.
Chartered Accountants / Mr C
Report dated 11 May 2018 (“first report”)
Mr C adopted the “value to owner” approach to value the Husband’s business. This is defined as:
“what a reasonable, prudent business person, in the position of the Husband, willing but not anxious to exchange the asset for cash, and reasonably informed of the relevant facts, would see as the cash equivalent of the relevant asset to him”.
The valuation methodology used by Mr C was the Capitalisation of Future Maintainable earnings which Mr C explained involves capitalising the estimated future earnings at a multiple which reflects the volatility and risk of the business and the stream of income it generates.
To determine the earnings of the Husband’s business, Mr C adopted the Earnings Before Interest and Tax (“EBIT”) approach. Mr C calculated the adjusted EBIT for the Husband’s business to be as follows:
2015 2016 2017 Net operating profit $562,185 $499,408 $646,711 Less/Add Adjustments* ($267,774) ($262,347) ($276,817) Adjusted EBIT $294,411 $237,061 $369,894 *In his adjustments, Mr C included a set figure for the Husband’s salary rather than 40% of gross fees minus laboratory costs.
To determine Future Maintainable Earnings (“FME”), Mr C adopted a weighted average approach giving the 2017 figures greater weight as follows:
2015 2016 2017 Adjusted EBIT $294,411 $237,061 $369,894 Weight 2 2 6 Weighted Average Adjusted EBIT $328,231 FME (rounded) $328,000
In determining the capitalisation rate, Mr C adopted a middle range of 3.5 to 4.0 with a mid-point multiple of 3.75. The factors he took into account in adopting this range included:
·the business services industry is in a growth phase forecast to grow at an annualised rate of 2.7% over the next five years to 2022/2023;
·the Husband’s business is subject to some economic regulations and industry pressures as are all other operators;
·IBISWorld statistics show average turnover for a business is estimated to be $734,000. The $1,000,000 turnover of the Husband’s business in 2017 is above average;
·the business has been running since 2009 so all start-up risks have been successfully negotiated;
·the business provides a range of services at competitive pricing;
·the catchment area has a high level of Chinese ethnicity and the Husband’s language skills and cultural background are the key attributes in retaining his current client base;
·there had been a 6% increase in fees revenue between 2015 and 2017 surpassing industry growth. There is a spare chair capacity evidencing potential for future growth;
·the Husband’s business attracts a high percentage of clients with private health insurance;
·the Husband’s business will continue to experience a high level of competition from nearby businesses; and
·the Husband’s business is highly reliant upon the Husband’s skills, expertise and relationship with clients. There is a key man risk in the business.
Mr C calculated the “Enterprise Value” of the business by multiplying the FME by 3.75, resulting in a figure of $1,230,000.
Mr C then calculated the goodwill of the business by taking the Enterprise Value of $1,230,000 and subtracting the net operating assets which he calculated to be $11,918, leaving a figure of $1,218,082.
From the goodwill figure of $1,218,082, Mr C deducted the total surplus liabilities of the Husband’s business which in the first Accountants report were listed as $292,092 to reach a value of the Husband’s business of $937,908 as at 30 June 2017.
Forensic Accountants / Mr D
Valuation report dated 26 September 2018
As noted in paragraph [11] of this judgment, Mr D was engaged by the Husband to review the valuations of Accountants and Chartered Accountants and prepare a “shadow valuation”.
Mr D adopted the value to owner (“VTO”) approach as the most appropriate basis for the valuation of the Husband’s business, noting that in the majority of cases the VTO may be the same as ordinary market value if there was no special value to the owner. Mr D concluded there was no special value to the Husband in excess of the fair market value and thus concluded all three valuers had applied the same approach to their valuations.
Having discussed valuation methodologies, Mr D adopted the capitalisation of future maintainable profits method as the basis of the valuation in his report, as did Messrs A and C.
Mr D identified three main areas of difference between the Accountants report(s) and that of Mr C’s as follows:
·different calculations of maintainable earnings primarily due to the weighted average adopted by Mr C and initially the simple average of Accountants in report one and then the use of the 2018 figure only in the second Accountants report;
·the different amounts allowed for the fair value of the Husband’s salary in the Accountants reports and Mr C’s first report;
·the different multiple applied to the maintainable earnings being 3.07 and then 2 by Accountants and 3.75 by Mr C.
When calculating the maintainable earnings (EBIT) for the purposes of his valuation of the Husband’s business, Mr D, as did Mr A in his second report, used the 2018 figures only as in his opinion the 2015, 2016 and 2017 no longer represented the current business operations. He calculated the EBIT for 2018 to be:
2018 Gross fees Husband $515,484 Contractors $297,135 Business fees reimbursed $20,928 Other income $83 $833,360 Less: expenses $363,121 Net profit $470,509 Adjustments ($256,982)* Maintainable EBIT $213,527 *Includes 40% of the Husband’s salary at $206,194.
In relation to the effective capitalisation rate, Mr D noted Accountants stated reasons for the reduction in capitalisation rate from 3.07 in their first report to 2 in their second report to be the poorly presented premises which would be unlikely to attract a purchaser, the commencement of a new Mandarin speaking business nearby and the general oversupply of medical professionals.
In paragraph [3] of page 9 of his report, Mr D challenged the Accountants reduction in the capitalisation rate from 3.07 to 2, stating:
“In my opinion there has been little change between 2017 and 2018 in the areas specified that are likely to cause such a significant reduction in value. In my view the reason for the decline in business performance in 2018 is primarily due to a major reduction in working hours by Mr Jung. Details are as follows:
·In previous years Mr Jung worked full days on Monday, Wednesday, Thursday, Friday and Sunday.
·As Mr Jung now undertakes substantial care of his children (118 days allocated in 2019) he works on Monday, Wednesday, Thursday and alternative Fridays until 2pm and alternative Sundays. On occasions he finishes work early in order to collect his children from school.
·Mr Jung only works half of the school holidays as he has custody of the children for the other half.
·Mr Jung looks after all the administration work (payroll, banking etc) which was previously looked after by his wife.
·As a result of the above, Mr Jung’s gross fees in 2018 were $515,000 compared to $825,000 in the previous year.
·The decline in Mr Jung’s working hours has been partly offset by an increase in contract medical professionals ($297,000 in 2018 compared to $178,000 in 2017).”
Mr D stated the capitalisation rate is “an area of subjective professional judgment”.[1] Both Mr A and Mr C agreed with this proposition when giving their vive voce evidence.
[1] Paragraph 2 of page 9 of Mr D’s first report.
Mr D applied a capitalisation rate of 3.0 stating at paragraph 7.8:
“I have applied a capitalisation rate of 3.0 times (Accountants Report 2 2.0 times) as I do not agree with the substantial decrease in the valuation for the reasons outlined in the Accountants Report 2. However I do consider that the poor presentation of the business makes it unlikely that a value based on a multiple higher than 3.0 times can be justified.”
Applying his multiple of 3.0 to the Maintainable EBIT, Mr D valued the Husband’s business at $640,582.
Chartered Accountants / Mr C
Report dated 2 October 2018 (“second report”)
Mr C prepared a critique of the report of Forensic Accountants dated 26 September 2018.
Mr C disagreed with Mr D’s report where it stated the client fees generated by the Husband in the FY 2018 is a proper reflection of his future earnings for valuation purposes.
Mr C is of the opinion the Husband’s FY 2018 figures are not a proper reflection of his future earnings. He undertook a forensic examination of the Husband’s practical working hours based on the school terms and holidays in 2019, adjusted for:
·the Husband’s parenting duties pursuant to Court orders;
·public holidays;
·current business operating hours;
·the Husband taking his annual leave when he has care of the children.
Mr C calculated the Husband had 203 days in the 2019 year when he was available to work which translated to 1,494 practical working hours.
Mr C then calculated that in 2017 the Husband worked 1,740 hours and when applied to his fees generated of $824,989, the Husband generated $474 in client fees per hour.
Using the hourly rate, Mr C expressed the opinion the Husband has the capacity to generate $708,353 in fees, particularly once family law proceedings are finalised.
Mr C therefore concluded the maintainable earnings used in the Forensic Accountants report based on the 2018 financial year is significantly understated and inappropriately adopted to calculate the Enterprise Value of the Husband’s business.
Adopting most of the figures used by Mr C to determine the EBIT for 2018 (see paragraph [64]), Mr C recalculated the adjusted EBIT as follows:
2018 Net profit $470,512 Add/(Less) Adjustments Adjustment for Husband’s fees $171,937* Accounting fees $19,881 Interest paid $30,177 Interest received ($83) Contractors fees ($118,854) Husband’s salary ($257,500)** Total adjustments ($154,442) Adjusted EBIT $316,070 * Being the difference between the $505,489 in fees actually earned by the Husband in 2018 and the $708,353 in fees Mr C calculated the Husband had the capacity to generate, less the laboratory fees allowed by Mr D as Mr C opined these should not be included in the income for valuation purposes.
** Being the $250,000 allocated in the previous report for the Husband’s salary adjusted by a notional 3% to reflect growth.
Applying a capitalisation rate of 3.75, as in his opinion there was no change to the business operating risks between 2017 and 2018, to his revised EBIT, Mr C’s updated valuation for the Husband’s business for 2018 was $1,052,302.
The Husband’s affidavit sworn 21 November 2018
In response to Mr C’s second report, the Husband swore and filed an affidavit on 21 November 2018 in which he “corrected” assumptions made by Mr C as to his work hours and capacity to work in his business.
The Husband calculated the maximum hours available for him to work in 2019 to be 1,392 hours. From those hours the Husband deposes to requiring:
·20 hours per annum for CPD;
·4.5 hours per week for business management;
·possible sick leave (at the time he swore his affidavit the Husband had a fractured finger); and
·commitments as president of the …Association.
Chartered Accountants / Mr C
Report dated 23 November 2018 (“third report”)
In response to the Husband’s affidavit of 21 November 2018, Mr C prepared a further report.
Based on the Husband’s affidavit, Mr C recalculated the Husband’s available hours to 1,190, rejecting the Husband’s argument that 20 hours should be deducted for CPD on the basis the Husband could undertake the required CPD at night or on non-working days.
Mr C recalculated the average fees generated by the Husband utilising his 2017 earnings. He deducted an additional 216 hours of earning time from his initial calculation of 1,740 based on the Husband’s evidence he requires 4.5 hours a week for business management. Mr C therefore calculated the number of hours worked by the Husband in 2017 to be 1,477. When divided into the fees generated by the Husband in 2017, being $824,989, Mr C calculated the average fees generated by the Husband in 2017 to be $559 per hour, not $474 as was his initial calculation.
Based on the “new” hourly rate for the Husband and the revised hours available to him of 1,190, Mr C recalculated the future maintainable earnings for 2018 as follows:
2018 Net profit $470,512 Add/(Less) Adjustments Adjustment for Husband’s fees $127,988* Accounting fees $19,881 Interest paid $30,177 Interest received ($83) Contractors fees ($118,854) Husband’s salary ($265,762)** Total adjustments ($206,652) Adjusted EBIT $263,860 * Being the difference between the fees earned and the Husband’s fee earning capacity calculated by 1,190 hours multiplied by $559.
** Being 40% of the Husband’s adjusted maximum earnings.
Using the multiple of 3.75 Mr C’s revised value of the business is $856,513.
Mr D’s response of 29 November 2018
By way of email to the Husband’s solicitors dated 29 November 2018 tendered into evidence at the final hearing, Mr D responded to Mr C’s third report.
Having noted Mr C had adopted 40% of fees earned as the calculation of fair salary for the Husband consistent with both the Accountants report and his own calculation, Mr D stated:
“I do not agreed with a basis to calculate Future Maintainable Earnings using potential MAXIMUM (refer notes A & E on page 5) earning capacity for the husband for 2 principal reasons:
·A hypothetical sale would never be negotiated on that basis. A reasonably informed purchaser would focus on the actual financial performance of the business with some regard to future prospects. The potential earning capacity of one medical professional in the business if able to operate at MAXIMUM capacity is irrelevant and should be disregarded.
·There is a glaring unspoken assumption that there are an unlimited number of clients “queuing at the door” ready to fill the additional hypothetical appointment times. The 2018 financial report clearly indicates the use of additional sessional medical professionals to compensate for the reduced hours of the husband. Evidence has also been provided by Accountants of an over-supply of medical professionals in the locality and it is quite unlikely that there is unfilled demand for businesses. (Professional Standard APES 225 para 5.2(l) requires the valuer to describe the material assumptions applied in a Valuation and the basis for those assumptions. In my view Chartered Accountants did not meet this standard)
Chartered Accountants adopt a mid-point Capitalisation Rate of 3.75 times in their valuation of the Enterprise. The factors taken into account in determining this factor are described in paragraph 68 of the report dated 11 May 2018. While a rate of 3.75 times is not unreasonable for an “average” business, there is no consideration of the following factors:
·The dilapidated state of the business premises. My site visit on 7 October, together with photos and direct conversation with the husband confirm that the external and internal presentation of the business is very poor. This is significant to the valuation (I note that Chartered Accountants have not visited the business premises nor spoken directly to the husband)
·Chartered Accountants have taken into account the on-going growth in the industry but have not considered the over supply of medical professionals entering the industry (refer details in Accountants report)
·Chartered Accountants consider the husband’s Chinese background and operating in a niche market as positive factors. However the husband’s affidavit confirms that there are 8 mandarin-speaking medical professionals in the locality. The husband’s Chinese background is not a positive factor
·In my opinion the business does not deserve an “average” rating. It is below average. In my valuation I applied a rate of 3.1 times*.”
*when giving his vive voce evidence Mr D advised 3.1 was an error and the multiplier used by him is 3.0.
Conclusion
As can be seen from the trail of the three expert reports and their vive voce evidence, the three experts agreed on several matters and remained apart on others.
Those matters agreed upon are:
·the basis of the valuation – whilst there was technically a difference as to whether “fair market value” or “value to owner” should be used, all agreed that as the Husband’s business offered no special value to the Husband value to owner value would be the same as fair market value;
·all adopted the capitalisation of future maintainable profits method as the basis of their valuation;
·all ultimately applied the “standard business” of 40% of fees earned to determine the business opportunity costs of the Husband;
·all used the FY 2018 figures as the basis for calculating the EBIT.
Where the three experts differed are:
·whether the 2018 EBIT should be based on the actual fees earned by the Husband in 2018 or the fees the Husband could generate if he worked every hour fully available to him; and
·what is the appropriate capitalisation rate.
The Capitalisation Rate
Mr A argues that the capitalisation rate should be 2 because of the decrepit state of the premises out of which the business is run, that there is an oversupply of medical professionals in the area in which the Husband works, the high level (65%) of clients utilising private health insurance and the lack of a guarantee of long-term occupancy.
When Accountants, for whom Mr A is a director, prepared their first valuation of the Husband’s business, they used a capitalisation rate of 3.07.
This capitalisation rate was subsequently reduced to 2 after Mr A personally visited the premises and saw for himself their dilapidated state.
Mr A explains the reduction in fees generated by the business from an all-time high in 2017 to an all-time low in 2018 as arising from the factors set out in the paragraph [91] of this judgment. When cross-examined, Mr A did not agree that the reduction in fees earned in 2018 was because the Husband dramatically reduced the hours he worked in 2018 compared to the hours he worked in 2017 even though the factors cited by him as being responsible for the reduction in fees were in existence in 2017.
Mr C applied a capitalisation rate of 3.75. In so doing, he considered the research that shows the business services industry is in a growth phase, that the average turnover for the business, particularly in 2017, was above the national average, that the business provides a range of services, the business is in a catchment area which has a high level of Chinese ethnicity and the Husband’s language skills and cultural background are a key attribute to his being able to retain his client base, the high percentage of clients with private health insurance and the business’ reliance upon the Husband’s skills, expertise and relationship with his clients.
Unlike Mr A and Mr D, Mr C did not visit or inspect the business premises or speak to the Husband.
Mr D applied a capitalisation rate of 3.0.
Mr D rejects the reduction in the capitalisation rate from 3.07 to 2 by Mr A on the basis that the reasons given by Mr A for that reduction, being the poor presentation of the premises, the commencement of a new Mandarin-speaking business and the general oversupply of medical professionals in the industry were all in existence in 2017 and were not the reason for decline in business performance in 2018. Mr D argues that the primary reason for decline in the business performance in 2018 was the reduction in working hours by the Husband in that year.
Mr D also considered the capitalisation rate of 3.75 used by Mr C to be too high as, having inspected the premises from which the business is conducted, he was of the view that its poor presentation would reduce its attraction to a potential purchaser.
All three experts agreed that the capitalisation rate applied for the purposes of valuation is very much at the discretion of the valuer and the particular weight they give to the multitude of factors that influence the determination of that figure.
Having considered the evidence of all three experts, I am of the view that the capitalisation rate of 3.0 utilised by Mr D most accurately reflects all the myriad of factors relevant to the valuation of the Husband’s business. These factors include the nature of the Husband’s business, the condition of the premises from which it operates, the lack of guaranteed occupancy (albeit all three valuers seem to be in agreement that they did not anticipate that the Husband would be at immediate risk of eviction), the Husband’s Chinese client base and the Husband’s language skills and ethnicity and that the business has, save for the last two years when the Husband worked excessively and then subsequently reduced his hours, maintained a fairly settled level of income. Mr D’s balanced consideration of all these factors is the most measured assessment of the appropriate rate to be applied.
The appropriate EBIT
As noted, all three valuers ultimately chose to use the 2018 figures as the basis upon which to calculate the EBIT.
Mr A and Mr D both applied the 2018 figures without variation as the basis upon which they calculated the EBIT. Their calculated EBIT was only $2,295 apart.
Mr C takes issue with the 2018 figures as they stand being the basis for the calculation of the EBIT, arguing that on the Husband’s own evidence he failed to work to his full capacity in 2018 when his commitment to care for his children, his administrative duties, leave and public holidays were taken into account.
It is therefore Mr C’s position that when calculating the EBIT to be utilised in ascertaining the value of the business, the figure that should be taken into account is not the fees actually earned by the Husband in 2018, but rather the fees that he could have earned had he worked to his full capacity.
Mr C performed a number of calculations to determine the hourly rate that should be applicable to the Husband’s earnings and the precise number of hours that the Husband would have had available to work.
Mr A was not cross-examined on this issue. However, he was adamant that the only valuation that this Court should accept was his as neither Mr C nor Mr D have his reputation or experience in valuing businesses.
Mr D rejected Mr C’s evidence that the basis for determining future maintainable earnings should be based on the Husband’s maximum potential working hours, arguing that any potential buyer would not be interested in hypothetical figures, but rather would focus on the actual financial performance of the business with some regard for future prospects. He stated that the potential earning capacity of one medical professional in the business if able to operate at maximum capacity is irrelevant and should be disregarded.
Mr D conceded that if the Husband worked a hypothetical further 100 hours per year, it would increase the value of the business proportionately. He was adamant however, that this was a purely hypothetical scenario and it would not be the basis upon which any potential purchaser would determine the purchase price for the business.
Mr D was also clear in his evidence that he did not accept that the Husband may have been deliberately reducing the hours he worked in 2018 in order to influence the value of the business. He highlighted the considerable increase in the income earned by external contractors in 2018 as evidence of the Husband ensuring that the clients of the business continued to have their needs met by the business and to offset his lack of availability arising from the demands upon him to care for his children and manage his business.
Finally, Mr D made the observation that it is unknown whether there was client demand to meet any hypothetical additional hours that the Husband may have been able to work over and above those he worked in 2018.
The only evidence in relation to whether there was client demand in 2018 was Mr D’s vive voce evidence that in his discussions with the Husband, the Husband had told him that the business was not opening on Sundays as there was no client demand for Sunday appointments and the costs of staff on a Sunday outweigh the financial benefit to the business.
There is a difficulty with Mr C’s revised calculation of the Husband’s hourly earning rate in his third report of 23 November 2018. Mr C deducted 216 hours of “earning time” in 2017 from the figure used by him to calculate the Husband’s hourly earning rate on the basis of the Husband’s affidavit sworn 21 November 2018 in which he deposes to requiring 4.5 hours per week for administrative duties. The deduction of 216 hours increased Mr C’s calculation of the Husband’s hourly earning rate based on 2017 figures from $474 per hour to $559 per hour.
However, the evidence before the Court is the Husband did not perform at least some of the administrative duties in 2017. Therefore the Husband’s hourly earning rate used by Mr C in his third report as the basis for his calculation of the value of the Husband’s business is incorrect and the valuation itself is clearly faulty.
That Mr C produced two different valuations of the value of the Husband’s business as at 30 June 2018 and could no doubt produce a third utilising yet a different hourly earning rate reflecting the administrative duties the Husband may have done in 2017, highlights the real problem with a valuation based on “hypothetical” maximum performance.
It is for this reason that I am most persuaded by Mr D’s evidence that a potential purchaser will look at the actual business figures and not some hypothetical figures when determining the market value of the business if they were intent on purchasing this business.
Accordingly, I am satisfied that the valuation provided by Mr D, both as to the capitalisation rate and to the EBIT, best reflects the value of this business and find accordingly.
I certify that the preceding one hundred and seventeen (117) paragraphs are a true copy of the reasons for judgment of Judge Bender
Date: 22 February 2019
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Family Law
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Expert Evidence
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