How to value a business in a divorce?

To value a business during a divorce, Financial Forensic experts will employ various methods such as the market or income approach to determine what a hypothetical buyer would pay.

Separating assets in a divorce can be one of the hardest aspects and can be particularly difficult where there is a business involved. Often one of the greatest difficulties is determining the value of the business so that the parties can agree how assets, including the business, will be divided between them at the conclusion of the divorce proceedings. The valuation is based on how much the business could be sold for, although this is generally theoretical since usually at least one of the parties remains within the business following divorce. 

If you are considering or going through a divorce and require an accurate business valuation from an expert Financial Forensics team specialising in Family Law, click the link below for a free initial consultation.

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Why is business valuation important in divorce? 

Providing a full and detailed disclosure of both spouse’s financial circumstances is a necessary part of determining how assets should be divided. This disclosure is provided by way of a document called a Form E if the financial aspect of the divorce is proceeding through the courts, which requires each spouse to list their worldwide assets, liabilities, and incomes.    

A business can be one of most valuable assets to be considered in the financial proceedings, particularly for UHNW and HNW clients and so it is essential that an accurate valuation of the business is obtained.   

Who will value the business? 

This will depend on various factors, including the size of the business and whether the parties agree. For a small business the parties could do the valuation themselves looking at the assets, cash flow or analysing comparable companies. However, it is generally preferable to get an independent valuation. 

A single joint expert (SJE) is commonly instructed to prepare a valuation report of the business to avoid disputes.  The SJE will often be a forensic accountant, and they are appointed jointly by the divorcing parties to prepare an independent valuation to assist the court. Both parties will receive an invoice for a share of the SJE’s fees, since both parties are liable to pay for the valuation. 

How will the business be valued? 

Therefore, there are a range of possible approaches to valuing a business upon divorce, as well as numerous additional factors that an instructed SJE may apply to adjust their final value. There is certainly no one-size-fits-all approach to the task. The courts are always keen to see that the most appropriate valuation method is used for the given circumstances of the case at hand. Some of the most common and appropriate methods of business valuation include: 

Market approach 

This method calculates the value of a business by considering what a hypothetical buyer would pay for the business from a hypothetic seller.  It relies on comparing the business in question with similar businesses which have an ascertainable market share price.   

A SJE may do this by considering the value of publicly traded shares in similar companies or examining transactions in which similar businesses - or even the business in question - have been sold or acquired.  

Cost approach 

This approach calculates value by estimating the costs of setting up an equivalent business from scratch. It is based on the idea that the value of an asset should be the cost required to replace or reproduce that asset.  For example, the net asset value of a business can be used in the cost approach. This will take the assets of the business, less the liabilities of the business, and ignore the future performance of the business. 

Income approach 

The income approach values a business by converting its future cash flow predictions into a single current capital value. The cash flow is discounted with a risk-adjusted discount to produce a present-day value and so this method is often called the ‘discount cash flow’ method. However, it is only suitable if the business has prepared detailed cashflow forecasts. 

An alternative for the income approach is the ‘Maintainable Earnings’ method, which calculates the earnings that a company is likely to sustain for the foreseeable future and multiplies these earnings by the number of years which a purchaser of the business might want to acquire. 

Comparison approach

This approach looks at the value of the business compared to the sales of comparable businesses. There are various ways to do follow this approach including: 

• Guideline public company method that bases the valuation on the market price of comparable market stock 

• Merger and acquisition method based on real-life examples of comparable companies that have been sold 

Dividend Yield approach 

This method is appropriate when the business interest being valued is a small shareholding in a company, for example, where a spouse is a shareholder with limited control of a business and does not own the business themselves. It values an individual’s interest in a business based on the dividends that an investor in that business would receive. 

Is there anything else a valuation report may consider? 

A SJE may also consider other factors which are relevant on the specific facts and circumstances of the business in question.  The following principles may result in an adjustment of the total value of a business: 

Key Man Discount 

This applies a discount to the value of the business on the basis that the running of that business is heavily reliant on a specific owner or manager. It seeks to reflect the reduction in the value that would result from the loss of that key individual. The key man discount may be particularly relevant for a successful, family-run business that relies on one individual’s skills or close relationships with supplier or customers for its continued profitability. 

Passive Growth 

This is the economic growth of a business that takes place by its own accord, such as the gradual increase in the price of land over time leading to an increase in the price of property that a business owns. Such growth cannot be assigned to either spouse’s active decisions. 

A Springboard 

Springboard refers to reflecting in the valuation what the potential value of a business was pre-marriage.  It is an acknowledgement of the fact that the value had, or even still has, the potential to increase significantly.