The Value of a Closely Held Corporation is its Investment Value

In Hewitson, husband and wife formed a closely held corporation during marriage. At the divorce trial, wife’s expert and husband’s expert valued the company using price-earnings ratio multiples derived from corporate acquisitions of public corporations. The divorce court used wife’s valuation. However, pending final judgment, the Court of Appeal decided in Marriage of Lotz (1981) 120 Cal. App. 3d 379, which held that privately held companies could not be valued using a price-earnings ratio from publicly traded corporations. Husband’s divorce lawyer corresponding moved for reconsideration and then appealed the divorce court’s valuation.

The Second District Court of Appeal agreed with Husband’s divorce lawyer and reversed the divorce court’s valuation under Lotz. The Court of Appeal explained that public acquisitions of comparable companies tended to be inflated and paid in stock rather than cash and therefore, these ratios did not accurately value closely held corporations. The Court of Appeal held that any reliance on price-earnings ratios from publicly traded corporations was improper because of the “unreliability of this method to determine the value of close corporation shares.”

In selecting the appropriate method to value a closely held corporation, the Court of Appeal held that the “investment value” of stock is the appropriate measure. The Court of Appeal outlined three general approaches for determining the “investment value” for a closely held corporation: (1) capitalization of earnings approach; (2) dividend paying capacity; and/or (3) book value or net asset value.

In re Marriage of Hewitson (1983) 142 Cal. App. 3d 874