SIXTH DIVISION

FILED: 02/11/99

No. 1-95-3583

JUSTICE ZWICK delivered the opinion of the court:

The petitioner, Barbara Grunsten, appeals from the judgment of dissolution of her marriage to the respondent, Richard Grunsten, challenging the trial court's distribution of marital assets, its award of maintenance and its findings regarding the payment of attorney's fees.

A substantial amount of evidence and testimony was presented in the trial court over eleven days between August 11, 1994 and October 24, 1994. However, only those facts necessary to an understanding of this court's decision will be set forth. The relevant facts will be discussed in the analysis of the issues to which they are pertinent.

I. Valuation of GSP Marketing Services, Inc.

Richard is the sole shareholder of an Illinois corporation, GSP Marketing Services, Inc. (GSP). GSP designs and produces mail order catalogs and performs other marketing services. The business was founded in 1979, and it is conceded to be marital property. The parties stipulated that GSP should be valued as of December 31, 1993. Each party retained accountants as expert witnesses for this purpose.

The trial court noted that similar approaches were taken by each accountant in valuing GSP. Both witnesses based their valuation on capitalizing the average earnings over a four or five year period weighted in favor of more recent years and discounted due to the a lack of marketability of closely held corporations. However, each used a different valuation method in reaching his final conclusion. Barbara's accountant valued GSP's shares using various economic assumptions and concluded the shares had a fair market value of $1,043,771. Richard's accountant valued Richard's shares as being worth $418,954.

As explained in the trial court's Memorandum Opinion and Order, Barbara's accountant used an "excess earnings" or "formula" method. This method assumes that the principal officers of closely held corporations take advantage of their ability to set their own compensation to minimize taxes by drawing out unneeded corporate profits in the form of salary and bonuses -- rather than as dividends -- in order to avoid the double taxation which occurs when corporations make profit.⁽¹⁾ Such compensation necessarily exceeds a lower level of compensation which could be paid to a non-owner hired to perform the same job. To compensate for this tax-avoidance practice, the excess payments are adjusted back into the corporation's history in estimating what its future profits are likely to be.

Barbara's accountant determined Richard's "normal" compensation by referencing a salary survey of chief executive officers of small businesses conducted by the Research Institute of America. For example, he found that Richard's 1993 salary was $282,463, of which $182,500 was "normal" and $99,963 was "excess." A weighted average of this adjusted annual compensation was then capitalized to determine the corporation's "goodwill."

The value of GSP according to Barbara's expert's method is expressed by the following formula: Value = Current (1993) net tangible assets + goodwill - discount for lack of marketability. The final estimate of $1,043,771 was derived by averaging various rates of return on net tangible assets and capitalization rates.

In addition to the above analysis, Barbara's expert noted that GSP had originally been started with another shareholder named Bob Simonek. Simonek owned 50% of GSP outstanding shares when he died in 1987 or 1988. On April 8, 1989, Richard entered into a written agreement with Simonek's widow in which he bought Simonek's shares for a cash payment of $245,246. In addition, Simonek's widow served as a consultant to GSP for a period of three years following Simonek's death at an annual salary of $45,833.34 per year. However, she was not at work very often in those three years and Richard could only recall her working on one of forty GSP accounts. The buyout also included furnishing $25,000 over ten years to establish an insured college scholarship for Mr. Simonek's daughter.⁽²⁾

In the fiscal year of Simonek's death, gross sales of GSP had been $6,204,909. By 1992, they had risen to $9,006,809. Given the increasing strength of GSP's financial position since the time of the Simonek sale, Barbara's expert stated that whatever value was placed on GSP, the terms of the Simonek stock purchase set a baseline for what 50% of the company was currently worth.

The report of Richard's accountant, who had a pre-existing relationship with both Richard and GSP, was based upon the "capitalization of earnings" method. This method assumes that various types of business investments entail different levels of risk. The risk is expressed in terms of a risk factor multiple ranging from 1 to 4 with no risk being given a value of 1 and the highest risk receiving a value of 4. The bench mark for measuring risk is the interest rate on 30-year government bonds, being 6.35 percent at the time of valuation. The capitalization rate is determined by multiplying the risk factor by the benchmark rate. Thus, the capitalization rate for a high risk business on December 31, 1993 is 4 x 6.35 = 25.4. The value of a high risk business on December 31, 1993 can then be expressed as follows: Value = 100 divided by 25.4 = 3.93 x weighted average of net annual corporate earnings - discount for lack of marketability.

Richard's accountant opined that GSP was a high risk business, principally because its value was closely tied to Richard's personal expertise and his relationships with clients. He also noted that GSP had a small customer base and that 60% of its sales were accounted for by only five clients. He computed GSP's weighted average annual net income to be $152,021, and he employed a 30% discount for lack of marketability. His computation of GSP's value was then expressed as follows: Value = 3.93 x $152,021 = $598,506⁽³⁾ x .70 = $418,954.

The trial court found that both accountants had been "flawed" in their analysis. The court stated that the assumptions of Barbara's accountant regarding "normal" and "excess" officer compensation to have been "wholly arbitrary." The court was also critical of Barbara's accountant's methodology in that he only "looked up numbers in a study whose parameters were not described, and the numbers were not specific either for the industry or geographic location." Indeed, the court specifically found that Richard's salary had not been inflated to avoid federal taxes. It noted that Richard was actively involved with all 40 of GSP's active clients and that he personally managed the five largest client accounts. The court also observed that GSP's chief salesman, Michael Zaremba, was paid over $400,000 in 1993, while Richard received only $282,463 that year. The court found Richard's expert to have used a proper methodology in calculating GSP's value, but determined that Richard's expert had overstated the riskiness of GSP's business. Rather than being a high risk business, the trial court stated that GSP should be considered as "moderately risky." In applying the correct risk factor to Richard's expert's formula, the trial court determined that GSP had a fair market value on December 31, 1993 of $558,677.

Section 503(c) of the Illinois Marriage and Dissolution of Marriage Act (Act) (750 ILCS 5/503(c) (West 1996)) requires that the court shall divide marital property in "just proportions." To apportion marital assets under section 503(c), the value of such assets must first be established. In re Marriage of Melnick, 127 Ill. App. 3d 102, 468 N.E.2d 490 (1984). Testimony concerning the valuation of assets in an action for dissolution of marriage are matters to be resolved by the trier of fact, and as long as the court's valuation is within the range testified to by the expert witnesses, it ordinarily will not be disturbed on appeal unless it is against the manifest weight of the evidence. In re Marriage of Wilder, 122 Ill. App. 3d 338, 349, 461 N.E.2d 447 (1983). As the trial court noted, determining market value for a closely held business is not unlike the evaluation process which must be applied in valuing professional corporations. The process is inherently subjective:

"Placing a fair market value on the professional corporation is an art, not a science, and the court must rely on expert witnesses to assist it in this difficult task. There is no exact formula that can be applied, so the trial court must rely on experts who may differ significantly in both methodology and valuation. The trial court must consider the relevant evidence before it; determine the credibility of the experts, the reasonableness of their testimony, the weight given to each of them, and their expertise in the particular area of valuation; and then determine fair market value."

In re Marriage of Gunn, 233 Ill. App. 3d 165, 183, 598 N.E.2d 1013 (1992).

On appeal Barbara argues, inter alia, that the trial court's valuation of GSP is against the manifest weight of the evidence because it is below the valuation Richard paid to Simonek's widow four years earlier, and because the evidence establishes that GSP's financial health had greatly improved since the earlier transaction. Barbara argues, as her expert did below, that the Simonek transaction should necessarily set the "floor value" for GSP. We agree.

Although valuation of a closely held corporation is subjective in nature, the process is obviously much less so when done with the benefit of viewing a similar transaction, particularly when the comparison transaction involves the same property. This is because fair value is best measured by what a willing buyer would pay a willing seller in a voluntary transaction. See In re Parker, 216 Ill. App. 3d 672, 575 N.E.2d 938 (1991). Here, on reviewing the record, we conclude that the trial court failed to give the Simonek sale sufficient consideration in assessing the value of GSP. Had the court done so, it would have been evident that Richard's expert's valuation was grossly inaccurate.

In our view, GSP cannot be reasonably valued at less than twice the value Richard gave Mrs. Simonek. Yet the trial court's valuation of $558,677 is clearly far below this threshold amount. The present value of the Simonek transaction can be logically calculated by adding the cash payment made to Mrs. Simonek ($245,246), the cash value of the $25,000 tuition payments, and any unearned salary Mrs. Simonek received in the transaction, and then adjusting this sum to account for the growth of GSP since the sale. In light of Mrs. Simonek's apparent lack of any articulable consulting skills and Richard's own concession that she was not at GSP very often during the three years she was paid as a consultant, it is clear that the salary payments made to Mrs. Simonek must be treated in large measure as consideration for the sale.

If extremely conservative estimates are applied to the unearned salary and scholarship payments and they are valued at 50% of their nominal cost to Richard, the total amount of consideration received by Mrs. Simonek for her shares is $245,246 (cash) + $68,750 (