What makes a good divorce business valuation?
Updated: Jun 13, 2019
The general principles of business valuation don't change whether it is for a divorce or selling your business or any other reason. However a good divorce business valuation will have some key differences to other business valuations and it is worth knowing what to look for in a good business valuation for a divorce settlement.
Given that approx one third of marriages end in divorce and there is more than 2 million businesses in Australia, it is very common for businesses to get stuck in the marital disputes that follow. The typical process is for the value of the business to be included as part of the family estate and then subject to any division agreed during divorce proceedings.
Is A Business Marital Property?
Whilst we do not have legal qualifications to answer this question, based on our experience, the short answer to this question is yes - any business interests, whether held in a partnership, sole trader, company or trust structure, can be considered by the court as property of the marital estate based on the Family Law Act. Each of these assets must be given a value in determining an equitable distribution of assets.
There may be some legal circumstances (such as pre-nuptial agreements) when a business may be excluded, but in most cases any assets (and liabilities) that are held jointly or severally by the partners in a long term relationship (defacto or married) will form part of the family estate, and will typically be subject to being divided in the event of a breakup. To get a clear answer on this you should seek expert legal advice from a family law expert.
In many family businesses, owners will have a share of the business. In these cases we are required to value the relevant shareholding or unit-holding related to the person(s) in the relationship. In order for us to arrive at a value of the share of the business we:
Value 100% of the enterprise (all the business assets less working capital).
Subtract net debt to arrive at an equity value.
Determine the value of the relevant shareholding or unit-holding.
The Basics of Any Good Business Valuation
There are some key principles that form the basis of any good business valuation (from our blog Basics of Business Valuation 101):
Transparency (how the valuation conclusion was arrived at should be clear and transparent)
Independence (the business valuer should be free of any influence through remuneration or other means to arrive at an independent conclusion).
Evidence-based (the information relied upon should be documented and reliable)
Structured process. (the process followed by the business valuer should be clear and documented).
Repeat-ability (can the business valuation be repeated by someone else with appropriate skills and experience using the information contained in the report).
Some features of a good divorce business valuation should include:
A clear and concise statement on what is being valued, the date on which it is being valued and the standard of value being considered (market value, liquidation value or value to the owner).
Clear statement of recent performance and an analysis of the business.
Determination of market-level wages of owners and the earnings adjusted to reflect these costs. Wages must be referenced back to wages reported to ATO and a clear description of the roles of both parties in the business.
Clear and conservative determination of ongoing earnings with documented evidence of any adjustments or addbacks made.
Structured process applied to determining any EBITDA multiple or capitalisation ratio (if this method is used).
Summary of relevant information used to arrive at an appraisal of value.
How Do You Value A Business For A Divorce?
As we have outlined previously, business valuation methods in a divorce are the same as any other valuation. They key difference is that more professionals and experts are likely to read and critique the business valuation for divorce purposes than in most circumstances. For this reason, the level of documentation can sometimes be greater in a business valuation for divorce than in other cases.
For businesses where a commercial return is not generated, but a suitable wage is provided to the owners then it may be relevant to consider the value of the business to the owner rather than the more broader concept of market value. In these cases the wages generated by the business may support a family or the parties to the relationship. The most appropriate method of valuation in this case is to use owners discretionary earnings applied to a lower than typical EBITDA multiple.
Court Standards and Content of Report
In most cases a business valuer is required by the court to prepare a report as an expert witness. The Family Court considers an expert witness as "...an independent person who has relevant specialised knowledge, based on the person’s training, study or experience and who can prepare an expert’s report that meets court requirements.
The Family Court has rules and standards for what must be in an expert's report. Among other things it must include:
A summary of instructions given to the expert witness.
A list of documents relied upon in preparing the report.
The reasons for the conclusions of the expert witness.
Statements about the methodology used in making the conclusions.
The expert witness’s qualifications.
Any literature or other material used in the report.
The relevant facts, matters and assumptions on which the opinions in the report are based.
A statement about the facts in the report that are within the expert witness’s knowledge.
Details of any tests, experiments or investigations relied on by the expert witness and, if they were carried out by another person, details of that person’s qualifications and experience.
Any range of opinions on matters dealt with in the report.
If required, any disclosure that a particular question or issue falls outside the expert witness’s expertise.
Qualifications and Experience of the Business Valuer
There is no regulatory body or formal training for business valuers in Australia. Both CPA and CA hold specialisation training courses for business valuation, however these courses are not mandated by any association or regulatory body.
Essentially a court requires someone who has the relevant industry experience, training and skills to provide expert witness. This is similar to ASIC matters, where the business valuer must have valuation experience within the industry that the business belongs.
As a minimum for business valuations for divorce the business valuer should be able to demonstrate:
Financial and business training which may include accounting, corporate finance and business management.
Understanding and compliance of APES 225 (Standard applied to Valuation Services as nominated by Accounting Professional and Ethics Standards Board)
Relevant court standards for Expert Witness reports
Five years’ experience in conducting formal business valuations for court purposes.
Primary principles of formal business valuation as outlined in APES 225 and IVSC Guidelines (International Valuations Standards Council).
Differences between enterprise value and equity value.
Requirements for using multiple methods of business valuation for divorce settlement.
Access to market transactions and other information to support any business valuation.
It is critical that the business valuer in divorce valuations can not only demonstrate experience and competence, but also independence. For this reason is it is important to not just engage your accountant or lawyer but a person who can investigate and opine on key valuation concepts and principles and how they dispassionately apply to your circumstances.
Can I Sell My Business Before Divorce?
If ever there would be an action that is likely to inflame any unpleasant emotions already present, selling the business before any divorce is finalised will do it. If you have sole ownership of the business over the other party this is one option. However it will not stop the value of the business being considered as part of the family estate and may even cause further problems.
Firstly, the other party is always going to claim you sold it for a lower than acceptable price just to prevent them from getting their share of the matrimonial estate.
Secondly, you may end up selling before the business is ready and miss out on a better price. A business valuation during a divorce will help prevent this from happening.
And thirdly, the courts have a wide variety of powers to "claw back" assets where they deem it that a particular party has been disadvantaged. So the court may well order a business valuation to be completed based on available information, ignore the price obtained in a sale and use the value determined in the appraisal for the purposes of arriving at a value of the asset pool.
It is much better to make decisions based on clear information, a reasoned approach and independent information rather than emotional over-reach. It is better to have a business valuation completed properly and focus on court process rather than try to "beat the system".
How Do I Protect My Business In A Divorce?
The business should really be protected from personal circumstances at all times - even when you are the business, as this always means you make better commercial decisions. Separate business and family finances, assets, and banking arrangements to ensure clear financial division between business and personal finances and assets.
Also, it helps in managing finances to for owners to pay themselves a salary - regardless how small or large the amount. This not only helps personal budgeting processes but also clarify discussions on who got what from the business.
Legal planning can protect you and your business from a lot of headaches, and minimise the impact of personal circumstances on the ongoing affairs of the business.
Key legal planning steps include:
Set up a binding financial agreement before, during or after the end of your marriage. This helps come to a reasonable understanding about how to divide assets, which can then be clarified with legal advice.
Put a buy-sell agreement in place with business partners that will set out what happens in the event of any changes in ownership. This can also set out how valuation disputes are settled.
Have clear shareholder or unit-holder agreements in place that spell out the roles each owner has, the expectations for any distribution of payments and profits and any special circumstances relating to business assets and liabilities.
Our whitepaper Business Valuation 101 (What You Should Know About Valuation) explains the theory of business valuation, why you need a valuation and the process of doing a valuation. Download a copy and feel free to contact us for an obligation-free confidential discuss.
If you want to know the value of your business and how growth will impact its potential value then give us a call and discuss a divorce business valuation and how it can help your situation.