How is the value of a business determined during a divorce?

The value of a business or interest in a business can be agreed upon or it will be valued via a business valuation. Learn how this value is determined.

If one or both spouses or partners owns or has an interest in a business their interest in the business will generally be included in the pool of property of the parties available for distribution. The value of the business or interest in a business can either be agreed or, if there is no agreement, it will be valued via a business valuation.

A business valuation is generally undertaken by forensic accountants experienced in business valuations. Because there is quite a bit of skill and detail involved these valuations don’t come cheap. For complex businesses, they can be downright expensive.

Is a valuation of the business necessary?

For a micro-business, the parties need to consider whether the business has any value at all apart from the underlying assets shown in the balance sheet. Often these small businesses have no goodwill and a modest income and it may not be a cost-effective exercise to get them valued. An experienced lawyer or accountant should be able to advise the client whether it is cost-effective or not.

However, if there is no agreement about the business’s valuation then generally the business interest will need to be valued if one person wants to retain it. On the rare occasion that neither party wants to retain the business, it can be sold so that the market can determine the value and the taxation and realisation costs are incurred.

The role of the Forensic Accountant in a Business Valuation

Where a business valuation is required the court or Arbitrator generally expects the parties to agree to engage a joint valuer. If there are court proceedings that valuer is generally appointed a ‘Court expert’. It is that valuer’s role to take an impartial role, gather relevant information and make the necessary enquiries and to produce a valuation.

That valuation is generally then used in the calculation of the pool of matrimonial property available for distribution and negotiations take place from there.

If a forensic accountant is engaged they will look at all of the important documents including the financial statements for a number of years. Depending on the complexity of the business they are likely to request a number of other documents. Sometimes they want to speak to the parties and sometimes they want to visit the business premises to get a better feel for the nature and complexity of the business and how it works. They might also want to talk to others such as Financial Controllers or bookkeepers.

The forensic accountants can adopt a number of approaches to valuing the business interest which I won’t detail here. This is an inexact science. There is quite a bit of discretion involved and there are generally differences in opinion even amongst the most highly regarded accountants. The truth is the value of a business interest can never be exact and the value generally changes from day to day. Part of the problem is that valuations are based on historical accounts some of which can be many months out of date. For this reason, it is common for business valuations to be updated during the course of the matter as new financial information becomes available.

Business valuations take in to account the value of the tangible assets of the business but also the “goodwill”. Goodwill is defined as “that intangible asset arising as a result of name, reputation, customer loyalty, location, products, and similar factors not separately identified.” It is hard to value and there are a number of correct approaches to doing it. There is enormous scope for disagreement as to the value.

Business valuations often have to take into account the complexities such as division 7A loans, taxation and realization costs. If one of the parties is a minority shareholder in a business then the accountant will generally advise on whether there should be a discount for the minority shareholding due to lack of control and marketability and how much that should be.

Valuations become more complex when rather than valuing the whole business only a part of the business owned by one of the parties is valued. Usually, it isn’t simply a matter of valuing the whole business then dividing it by a percentage. Usually, there is a discount because few people are interested in buying a business owned partly by somebody else. The discount is usually greater if it is a minority interest because the owner has little or no control of the business.

It is usual for the forensic accountant to do a thorough valuation based upon the information provided and their own enquiries. However, sometimes the parties will agree or the court or Arbitrator will order a limited scope valuation. For example, the joint expert may be engaged only to value the discount for a minority shareholding.

Often one or both parties will engage a ‘shadow expert’. Sometimes that expert is the accountant who has previously advised the parties regarding the business. Other times one or both parties will separately engage anothfer experienced forensic accountant to review the valuation of the joint expert, produce their own valuation and to advise regarding valuation issues generally.

If it goes to court or Arbitration

Should a matter proceed to a trial or Arbitration the report from the joint expert will generally be put into evidence. The evidence from the joint expert will usually be challenged by the lawyers for one or both parties. However, if a party has engaged a shadow expert they can usually put a report from that expert into evidence. That evidence is very likely be challenged by the lawyers for the other party. It is then up to the judge or Arbitrator which expert’s evidence they prefer and to make a finding as to the value of the business interest.

In exceptional cases where there are vast differences of opinion as to the value of a business interest the case may go to trial or arbitration so that an independent umpire can make a decision. However, in the vast majority of cases the valuation is used in the negotiations which lead to an agreement between the parties. Usually, the sooner it is done the better. Lengthy litigation can take an enormous toll on a business.

The Show Must Go On…

A Guide to Help Small Business Owners Better Understand & Navigate The Separation Process.

The Show Must Go On...

A Guide to Help Small Business Owners Better Understand & Navigate The Separation Process.
The guide includes:

  • An overview of the impacts a separation can have on your personal life & business.
  • A summary of the complexities small business owners will face when going through a separation.
  • An explanation of the family law process that small business owners will face.
  • Ways small business owners can limit the stress and impact that their separation has on their business.