Valuing a Minority LLC Interest in a California Divorce: Why 10% Ownership May Not Equal 10% of the Value

By Evelyn M. Rodriguez, Senior Litigation Manager, Fenchel Family Law, PC

If you or your spouse owns part of an LLC, partnership, family business, or real estate investment company, one of the biggest financial questions in your divorce may sound deceptively simple:

What is that ownership interest actually worth?

Suppose you or your spouse owns 10% of an LLC that holds a $10 million commercial property. It may seem obvious that the interest is worth $1 million.

It may not be.

In a high asset California divorce, getting this question wrong can affect hundreds of thousands of dollars in the ultimate property division.

There are two different questions:

What is 10% of the value of the assets owned by the LLC?

and

What is the actual value of the 10% LLC interest?

Those questions can produce different answers.

If an LLC owns a property worth $10 million, calculating 10% of the property’s value gives you $1 million.

But consider a different question: Would an unrelated buyer actually pay $1 million for that 10% LLC interest?

Perhaps not.

A buyer of the 10% interest may have no authority to sell the building. The buyer may not control when profits are distributed. The buyer may not be able to force the other owners to buy the interest. The buyer may have limited voting rights. The operating agreement may also restrict when and to whom the interest can be sold.

That is why simply multiplying the underlying asset value by the ownership percentage may not tell the whole story.

Valuation is not simply an accounting exercise. The number assigned to an ownership interest can directly affect what you keep and what you give up in your divorce.

Suppose you own the 10% LLC interest and keep it after the divorce. If the community interest is valued at $1 million, that value becomes part of the overall property division. Depending on the characterization of the interest and the rest of the marital estate, you may need to give your spouse substantially more cash, investment accounts, retirement assets, real estate equity, or other property to equalize the division.

But imagine the LLC interest cannot realistically be sold for $1 million because you lack control and there is no meaningful market for it.

You could effectively be exchanging highly liquid assets for an ownership interest whose economic value is substantially different from the number appearing on the marital balance sheet.

The opposite problem matters just as much.

If your spouse owns the interest and argues that it should receive a substantial discount, an unsupported or inappropriate discount could reduce the value assigned to the community estate and leave you receiving less property than you should.

The goal is not automatically to discount the interest. The goal is to identify exactly what is being valued and use an appropriate valuation methodology.

Liquidity matters.

One million dollars in a bank or brokerage account is readily accessible.

A purportedly $1 million minority interest in a privately held LLC can be very different.

The owner may be unable to sell the interest freely. The owner may be unable to force a distribution. The owner may have no control over the underlying property. The owner may have to wait years before the investment can be converted into cash.

On a marital balance sheet, both assets might initially appear with the same $1 million figure.

Economically, however, they may be very different.

That distinction is one reason sophisticated divorce counsel should examine not only the assets held by an entity, but also the rights and restrictions associated with the particular ownership interest.

Two concepts may arise when a partial business or LLC interest is valued.

A lack of control, sometimes referred to as a minority interest, discount addresses the fact that someone who owns a relatively small percentage of an entity may have limited ability to control what the entity does.

A lack of marketability discount addresses a different issue: how difficult the ownership interest may be to sell.

Consider the difference between owning real estate worth $2 million and owning a minority interest in an LLC whose principal asset is $2 million of real estate.

The real estate itself may potentially be marketed and sold.

A minority interest in the entity that owns it may not be nearly as easy to convert into cash.

These concepts do not mean that every minority ownership interest should receive a discount in a California divorce. Whether an adjustment is appropriate, and how it should be calculated, depends on the facts, the ownership rights, the valuation methodology, and applicable California law.

If you or your spouse owns an LLC interest, the operating agreement can be critical to understanding its value.

Among other things, it may tell your attorneys and valuation professionals:

• who controls the company

• who can sell company assets

• how and when distributions are made

• whether an owner can sell an interest to someone else

• whether other members must approve a transfer

• whether an owner can force a buyout

• what happens when an owner wants to leave

• what voting rights accompany the interest

The percentage of ownership is only part of the picture.

Two people can each own 10% of different LLCs and possess very different economic rights.

The scope of the valuation matters.

An expert can be asked to value the underlying real estate and calculate 10% of that value.

Or qualified valuation professionals can be asked to determine the value of the actual 10% ownership interest, considering the characteristics and restrictions associated with that interest.

Those are not necessarily the same assignment.

In some cases, more than one professional may be appropriate. A real estate appraiser may determine the value of property owned by the LLC, while a business valuation professional analyzes the partial ownership interest itself.

That additional analysis costs money.

But when the underlying assets are worth millions of dollars, a seemingly small difference in valuation methodology can potentially translate into a substantial difference in the marital estate.

This is not unusual.

One spouse may argue that the ownership percentage should simply be multiplied by the value of the underlying assets. The other may contend that the actual ownership interest should be separately valued.

That disagreement should be identified early.

Depending on the circumstances, the parties may agree on a jointly retained expert, retain their own experts, negotiate the appropriate scope of the valuation, or ask the

court to resolve a dispute concerning the valuation process.

Waiting until an appraisal is finished to identify a problem with the methodology can create unnecessary expense and delay.

If someone tells you, “My spouse owns 10%, so it is worth 10%,” that may be the beginning of the valuation analysis rather than the end.

The reverse is also true. The fact that someone owns a minority interest does not automatically establish that the interest should be discounted.

The entity structure, operating agreement, ownership rights, underlying assets, transfer restrictions, valuation methodology, and applicable California law can all matter.

For spouses with substantial wealth tied up in privately held companies, family LLCs, partnerships, or real estate investment entities, getting the valuation methodology right can materially affect the financial outcome of a divorce.

Before negotiating away cash, retirement assets, investment accounts, or real estate based on a value assigned to a privately held ownership interest, make sure you understand what is actually being valued and why.

About Evelyn M. Rodriguez

Evelyn M. Rodriguez is Senior Litigation Manager at Fenchel Family Law, PC, with approximately three decades of legal experience. She represents and helps lead the firm’s work on sophisticated California family law matters involving substantial assets, business interests, real estate, complex financial structures, and challenging property division issues.

Fenchel Family Law, PC represents clients in high-asset and complex divorce matters throughout San Francisco and the greater Bay Area.

This article provides general information and is not legal advice. Whether a particular valuation methodology or discount is appropriate depends on the specific facts and applicable California law.

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