During the divorce process, the parties are required to exchange financial disclosures including, but not limited to, the disclosure of all assets and debts. The assets and debts must be valued before they can be classified as community or separate property, and subsequently allocated between the parties pursuant to a divorce. Not all assets are easily valued, like a bank account or a vehicle, but rather require an expert opinion to determine their value. For example, residential or commercial real estate frequently requires the assistance of an appraiser, or competing appraisers, to opine as to the value of the subject property. This holds true when one or both parties own an interest in some form of a business. Family law attorneys frequently work with business appraisers and accountants who provide their expert opinion on the value of a business. It is important to reach an understanding with your expert on certain factors, as discussed below, before the appraiser begins his or her valuation process.
Date of Valuation
The business will be valued as of a certain date in time. This date must be agreed upon before starting the valuation process. In California, businesses are commonly valued at the date closest to trial. However, alternate dates, such as the date of separation of the parties may be considered depending on the circumstances of the parties. To use an alternate valuation date, (other than a date closest to trial) one may have to show cause and obtain a court approval. Because a business’s value can fluctuate significantly from one date to another, the selection of a date of value is a very important milestone. It is not unusual for a business’s value to increase or decrease significantly post-separation due to external factors such as the economy or to intentional actions by the spouse operating the business to depress value.
Different dates of value may also require the use of different valuation metrics, e.g., using higher or lower price/earnings and price/revenue multiples.
Standard of Value
The proper standard to use in valuing a business has been subject to debate, and also varies by state. Courts refer to the standard of value in different terms such as going concern value, investment value, and even just value. In California, the generally accepted standard is fair market value. Fair market value is defined as the price at which the business would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or to sell and both having reasonable knowledge of relevant facts. The standard of value used can have a significant impact on the ultimate valuation opinion. Statutes, case law and local court rules often provide guidelines in this matter.
Family law attorneys and appraisers need to spend significant time learning the workings of the business. It is imperative that both the attorney and the appraisers have a comprehensive understanding of how the business works. This can be accomplished in many ways.
Onsite visits of the company and/or company locations are the first step in learning about the business. Both the attorney and the expert should visit the company to see how the company functions on a day-to-day basis. What better way to learn about a business than to see it yourself? The appraisers and forensics will also conduct management interviews with individuals such as majority shareholders, president, vice presidents, chief of operations, marketing personnel, and bookkeepers or the financial department, to obtain information to assist in determining a value.
Appraisers and attorneys review all pertinent financial and legal documentation to identify and value a business. Legal documents provide an understanding of how the business is set up. For example, whether it is intertwined with other companies, whether the company owns real property that would also need to be valued, or whether the business rents back the real property to itself for a fair price. These types of related-party transactions often distort the value of the business and must be verified and adjusted, if necessary, to ensure that the valuation is accurate and does not favor either party.
Valuation professionals review tax returns, financial statements, bank records, internal ledgers, projections, budgets and sometimes, even invoices and deposit slips, to ascertain accuracy and compliance with tax and accounting principles.
Professionals with substantial experience in valuing businesses for marital dissolutions will know how to effectively detect problems, fraud, under-reporting or diversion of funds, adjust for those and reach an equitable business value to withstand court scrutiny and be acceptable to both parties.