THE USE OF BUSINESS VALUATIONS IN DIVORCE
Many of our high-asset clients are the owners of a business. It is not uncommon for married couples to co-own a small business or one of the parties to run and manage a small privately held firm. During the dissolution process, the business has to be valued for distribution as a part of the overall division of assets. Usually, the business is the single most valuable asset in the marital estate. As such, the business valuation is the single-most important issue in the divorce.
Let us help with your business valuation. Contact us at (503) 223-8441 for a free business valuation consultation.
There are a few specific issues that arise in business valuations. Understanding the basic approach to value is essential to obtaining your fair share of the marital estate. There are clear standards for the business valuation process and case law specific as to how businesses are to be valued in a divorce. A proper business valuation generally requires a qualified business valuation expert to prepare a report and to make a valuation presentation in court.
A business valuation requires a skilled business valuation attorney to obtain the necessary financial records to evaluate the business. The business valuation expert will also assist the attorney and client in obtaining financial records crucial to the business valuation process as efficiently and cost-effectively as possible.
At the Law Offices of Paul F. Sherman, we pride ourselves in assisting our clients in business valuation issues and choosing a highly-qualified business valuation expert for your specific industry.
UNDERSTANDING THE BASIC APPROACHES TO BUSINESS VALUATION
One of the most contentious issues in a divorce proceeding is the valuation and distribution of a family-owned business. This process can be complicated and expensive depending on the nature and the size of the business. Often the business is the most valuable asset in the marital estate. Whether you are the “in” or “out” spouse, it is essential to understand the various methods which are generally applied to determine the value of a family-owned or privately held business. Different approaches to value often lead to different valuation conclusions and it is the responsibility of the parties, their attorneys and experts to persuade the judge to reach an appropriate business valuation.
WHAT KIND OF ASSETS ARE CONSIDERED IN A BUSINESS VALUATION?
While each business has unique features, all business will own tangible and intangible assets. Tangible assets generally consist of cash, accounts receivable, inventory and equipment. Intangible assets are non-physical assets, such as trademarks, patents, copyrights, goodwill and contracts that grant various rights and privileges. The valuation of tangible and intangible assets usually requires an expert who may utilize different standards of value.
While all valuations are prepared as of a single date, it is important to understand what date the court will use in determining a proper business valuation in your case. The foundation for a proper business valuation is the application of recognized valuation methodologies with rigorous analysis of the underlying financial records of the business. Every business valuation will include subjective judgments made by the business valuation expert in arriving at his or her conclusion. It is rare when two business valuation experts arrive at the exact same conclusion as to value. Thus, it is important to understand how assets are valued and the basics of the business valuation methodologies.
To determine a business valuation for a divorce, the parties generally retain their own expert to prepare a business valuation opinion in the form of report. The experts will then testify in court as to the foundation of their opinion. They will explain their work, analysis and opinions as to value. The expert will also comment on the work of the opposing expert and the flaws and errors in their report. As a general rule, it is in the judge’s discretion to decide what value to adopt. A well-prepared business valuation approach will provide a business value for each of the accepted methodologies.
HOW ARE BUSINESS ASSETS VALUED?
There are three accepted approaches to determine a proper business valuation (1) the asset approach; (2) the income approach and (3) the market approach.
While there are no other approaches as to value, there are numerous methods that an expert may consider in each of these accepted approaches. Each business valuation approach has inherent strengths and weaknesses and some provide a more reliable conclusion of value than others depending upon the individual circumstances and the type of business involved. The valuation experts should consider all three approaches in his or her report. However, quite often not all three approaches can be applied to a specific business. For example, in an asset approach, a business valuation expert may seek to value intangible assets. It can be extremely difficult to find reliable data to value individual intangible assets for many businesses. Intangible assets are also frequently captured in the proper application of the income and market approaches. Ultimately, it is the responsibility of the parties and their counsel to persuade the court that their expert’s valuation conclusion is more reliable than the approach exercised by the opposing expert.
WHAT IS THE ASSET APPROACH?
The asset or asset-based approach determines a value indication of a business or business interest based on the value of the business assets less liabilities. Generally, the asset approach presents a value of all tangible and intangible assets as well as the company’s liabilities.
While the asset valuation approach may seem to be simple, there are a number of complicating factors. The determination of book value is often problematic. This is especially true with certain asset classes such as property and equipment which are seldom the equivalent of book value. Such items may require separate experts to provide appraisals for individual items. The value of inventory is typically stated at cost and depending upon the inventory type and age, this is another asset whose value for business valuation purposes is frequently not the same as book value. Intellectual property valuations are always challenging under an asset approach valuation. Accordingly, the asset approach is typically relied upon when the business is an investment or holding company. It can also be used in the valuation of very small business and/or professional practices where there is little or no goodwill.
WHAT IS THE INCOME APPROACH?
The income approach determines the value of a business using one or more methods that convert anticipated economic benefits into a present single amount. The income approach is the most widely recognized approach to valuing an interest in a privately-held business. There are several methodologies within the income approach. The primary methods are capitalized cash flow, discounted cash flow and excess cash flow. Each of these methodologies requires the determination of a future benefits stream and a rate of return and risk that the projected future economic benefits will actually be received by the business. To determine a future benefit stream, the valuation expert will collect and review historical financial data and make normalizing adjustments.
The business valuation expert will collect and review historical financial data and make normalizing adjustments to develop a conclusion as to the future benefit stream for the business. The goal in making these adjustments is to present a normal operating picture to project future earnings for the business. In most privately-held businesses, it is not unusual for the controlling shareholder to receive compensation in excess of the market rate. As such, one of the significant adjustments made by a valuation expert is to add back excess compensation to the business cash flow. The business valuation expert must determine a fair rate of compensation for the controlling shareholder’s position and responsibilities. As such, there are many subjective judgments that the business valuation expert must make when using an income-based approach.
WHAT IS THE MARKET APPROACH?
The market-based approach determines the value of a business by comparing the subject business to similar businesses that have been sold. This approach essentially develops a list of comps to indicate the selling-value of the business. Here, the value of the business is determined by comparing sales of other like-kind businesses. People are familiar with the market approach because it is commonly employed by real estate appraisers to determine value in real estate transactions. The approach works well particularly with residential appraisals due to the fact there are usually many comps for homes with similar qualities including size and location. For most privately held businesses, it is much more difficult for a business valuation expert to find transactions that are comparable to the business being valued. Usually, the business being valued is a small privately-held firm and the majority of the transactional information is from public companies with greater differences in size, sales, profits and geographic location. While the market approach is simple to understand, it can be extremely difficult to find transitions that are truly comparable in terms of the business whose sale is being reported.
THE VALUATION CONCLUSION – WHAT IS THE BUSINESS ACTUALLY WORTH?
Once a proper evaluation has been made using each of the accepted approaches, the business evaluation expert with need to make a final valuation conclusion. There are many additional components that must be analyzed before the business valuation expert can arrive at a final conclusion of business value. These factors generally include adjustments for control, premiums, discounts for lack of control, discounts for lack of marketability or lack of voting rights and other such adjustments. Once the business valuation expert has applied all three approaches and arrived at value indications for each approach, the determination must be made on how much weight to give each value indication to determine a final value conclusion. Once established, the expert should perform a reasonableness test to determine whether or not the opinion makes economic sense.
The sheer multitude of variables involved in the valuation process is complicated and can make business valuations difficult for the average person to understand. Moreover, there is very little training available to help family law judges understand the intricacies of business valuation. As such, it is imperative that the attorney be well versed in business valuation methodology to obtain a proper business valuation.
CONTACT PAUL F. SHERMAN FOR EXPERT ADVICE ON YOUR BUSINESS VALUATION
At the Law Offices of Paul F. Sherman, we pride ourselves in effectively assisting our clients in the business valuation process. We are experts in high asset or high net worth dissolutions involving privately held business.
We know you have more questions and we have answers. If you would like to learn more about business valuation, call the Law Offices of Paul F. Sherman at (503) 223-8441 or Contact Us for a free business valuation consultation.