New Jersey courts have long recognized that the valuation of a closely held business is often a difficult, intricate and sophisticated a task that requires expert testimony. One court has even described the valuation of a closely held business as an attempt to determine the value of an asset that by definition does not have a fair market value.
In a few jurisdictions, testimony of a business owner as to its value has been permitted on the theory that, by virtue of ownership, the owner possesses a unique insight into its worth. While lay testimony as to value in not unusual in cases involving other ordinary personal property, such as a carpet, a car or a home repair project, for example, no New Jersey court has allowed this kind of testimony for a business. Given the unique nature of a closely held business, New Jersey courts have uniformly assumed that opinion testimony on value can only come from an expert.
The principal argument for precluding an owner from testifying about value is that an owner typically lacks the experience and training to evaluate the worth of something that has no readily discernible market value. The valuation requires an analysis to determine what a reasonable investor might be willing to pay for an interest in something that may never have been sold and for which there are no comparables. The New Jersey Supreme Court has articulated at least seven factors that should be considered before a valuation of a closely held business can be performed. These factors include (1) the nature and the history of the enterprise; (2) the economic outlook in general, as well as the specific industry condition and outlook; (3) the book value of the stock and the financial condition of the business; (4) the earning capacity of the company; (5) its dividend-paying capacity; (6) whether or not the enterprise has goodwill or other intangible value; and (7) the size of the block of stock to be valued. See Bowen v. Bowen, 96 N.J. 36, 44 (1984)
With all of this information in hand, an appraiser then must exercise professional judgment in selecting the most appropriate method for determining value. Typically, three methods will be evaluated: (1) capitalization of indicated earnings at a reasonable return on investment, based on relative risk and current interest rates; (2) comparison with price-to-earnings ratios of publicly traded companies in the same or comparable industry; or (3) appraisal of all underlying assets, tangible and intangible, with adjustment for existing liabilities. Courts have consistently held that, whatever method is chosen, opinions of value must be based upon evidence in the record or evidence of proven acceptance in the field. Although a business owner could offer credible insight into some of the relevant underlying factors, including the history of the enterprise, the financial condition of the business and the size of the interest to be valued, without significant knowledge and training in techniques of valuation, owners do not possess the expertise necessary to assess all relevant factors, apply them to a proven methodology and calculate a reliable value for their closely held business.
The circumstances relevant to appraising a closely held business distinguish the situation from the valuation of other personal property, for which lay opinion as to value may be permitted. Valuation testimony from business owners is likely to be unreliable, since they not only have an incentive to inflate the value their business, but the financial information about the business itself is often subject to question. Closely held businesses are unlikely to have audited financials statements and, in many cases, have no financial statements, or have books and records that are maintained haphazardly, if at all. In addition, owner compensation and reimbursement arrangements may not reflect market norms and may have to be normalized before the business can be valued. Finally, the valuation must account for other peculiarities of the business, such as the concentration and condition of its receivables, overdependence on a few suppliers or customers, and the importance of key employees or owners to the continued viability of the business. Only a properly trained expert is qualified to competently assess whether such factors exist and, if so, determine the impact they have on value.
Unlike ordinary personal property, which is within the ken of an average juror or judge, the valuation of closely held businesses is so complex that it requires the skill and experience of an expert. For that reason, while owners can be permitted to offer relevant, factual information about the business, they ordinarily should be barred from offering any opinion about the value of their closely held business.