Business Valuation in a Divorce And Forensic Accounting
Business owners going through a divorce often become more amenable to a settlement the moment they realize that the other party has hired a forensic accountant to scrutinize their business statements and transactions.
When only one of the spouses has been running a business, it can be quite tempting at the time of divorce planning to disguise personal expenses as a business expense in a bid to undervalue or tank your business.
Expect the valuation if you are a business owner
It is almost impossible to avoid business valuations in divorce lawsuits, where the spouse(s) are business owners. A common perception with most divorce business valuations is that many unnecessary expenses may have occurred, which would bring down the total value of the business.
The other spouse may also feel that business expenses and liabilities may have been falsely inflated, while business assets may have been hidden craftily by creating shell companies. Clearly, they would hire a forensic accountant’s services for true business valuation if they have such fears.
Concerns are shared by the non-business owner
It is not just the business owner who has concerns about the other party hiring a forensic expert. Here are some of the common concerns of the non-business owner:
- Will the valuation go forward fairly?
- Can the business owner spouse be prevented from artificially lowering the business’s value?
- Is it possible to avoid costly and unreasonable delays in the process?
Fortunately, the business valuation process in a divorce can be conducted in an efficient and fair manner. Every business is of some value, regardless of it being small or large.
Some experts simplify the ‘valuation’ process by stating that the current true value is what an unhurried buyer shall offer for the business and the amount which an unhurried seller shall accept for the company. While this is a simplistic approach to look at things, reality can be far more complicated.
Different Approaches to Business Valuations during a Divorce
Here are the three primary approaches are taken by business valuators or forensic accountants while valuing a business:
- Asset-based approach
- Income-based approach
- Market-based approach
These approaches can be used singularly or in combination to take the following into consideration:
- Business profits by analyzing the profit and loss statement
- Business goodwill
- All tangible and intangible assets
What is meant by business profitability?
Profit is the remaining balance after subtracting all business expenses (not personal) from the business revenue.
What happens to personal expenses categorized as business expenses?
There are many business owners who classify certain expenses as a business, which are not deductible as per IRS standards. These expenses include partially deductible expenses that have been classified as deductibles.
These nondeductible expenses can be ‘add-backs’ and a business valuator, while measuring profitability, may remove these from the expense column. Add-backs increase business profitability, and in turn the income of the business owner.
What is a business asset for valuation purposes?
Business assets for a business selling ‘goods’, includes personal property, such as inventory and equipment. However, this usually depends upon the company and industry.
In the case of a professional service business, inventory and equipment, such as computers or desks are not usually seen and are rarely of any significant value. These companies, in turn, consider goodwill as their most significant asset.
How is Divorce Valuation for a Business with Real Property Carried Out?
Property is one of the major assets of a business owning real estate
Businesses that own real estate, typically, hold the same in a separate entity, such as a limited liability company (LLC).
This LLC is treated as an independent business for valuation purposes during the divorce.
If the business has not created a separate entity for real property owned by them, then the estate is considered an asset of the actual company.
Business assets can be intangible
Businesses have intangible assets, such as intellectual property, and these are also considered during valuation.
Following are some common intangible assets:
All the above are of value and considered as such during the business valuation process.
Who should Perform Divorce Business Valuation?
There are several options available to spouses:
- The first option is to try and figure out on your own, but this can be self-defeating if you are not an expert
- The second option is to hire a professional joint forensic accountant who shall value the business objectively
- The third option is that each spouse hires their separate forensic accountant to protect their individual interests
Option 1: Self Valuation
Trying to figure out the business valuation on your own is a bad idea, without exception. You run a serious risk of undervaluing or overvaluing the company unless you or your spouse has an actual business valuation experience.
You also need to employ due diligence similar to forensic accountants and other business valuators.
Option 2: Joint Forensic Accountant
You should trust the joint forensic accountant to provide a proper valuation in joint endeavors.
It is important for both spouses to rely on the accountant’s analysis and results during negotiations to come to a quick divorce settlement. It’s critical to note that joint forensic accountants do not provide legal advice.
Spouses can also hire a separate forensic accountant along with the joint forensic accountant to review the work. However, the only potential benefit of hiring a joint forensic accountant – cost, shall be lost in this situation.
You may find it to be common sense to hire a joint financial accountant since it will cost less. In most cases, you would be right, but you may be wrong as well.
Just because you jointly agree with your spouse to hire one forensic accountant does not mean that you will agree with the accountant’s valuation figure.
This would warrant one of you to hire another forensic accountant. But, what if both of you disagree and then go on to hire separate forensic accountants to conduct the valuation.
This means you would have together paid for three forensic accountants to carry out a single business valuation.
There are different ways spouses can agree on hiring a joint forensic accountant to carry out the business valuation:
- The agreement can be done informally.
- A contract can be signed by the spouses with the joint forensic accountant. However, they do not make the contract a court report.
- The forensic accountant can be appointed as the court’s expert by the spouses.
The last option means that the forensic accountant is appointed with a court order and that the accountant is now a court’s expert for the purpose of business valuation.
There is a measure of benefit and risk with each option, which is highly dependent on individual cases. It is important that you consult with your divorce attorney to get a full picture of the associated risks and benefits.
Option 3: Separate Forensic Accountants
Hiring separate forensic accountants is not as contentious as it may sound since the accountants don’t go to battle. Instead, they each gather the same information to determine the business value.
But, because business valuations are highly dependent on individual perspectives, it is possible for reasonable minds to sometimes disagree.
However, forensic accountants always try building a bridge towards a compromise through active communication.
In situations, where there is a discontent between the forensic accountants, and both have reasonable arguments to support their validations, lawyers and spouses can cooperate to come to a compromise.
However, litigation may be unavoidable if:
- any one of the accountants is unreasonable or overreaching
- the amount in dispute and facts surrounding the valuation justify it
- either spouse wants their day in divorce court regarding the valuation of the business
No one wishes for a contested divorce, but these are generally unavoidable when there are disagreements. The disagreements can be both reasonable and unreasonable. It may be best to take matters to the court if spouses have serious disagreements involving significant amounts of money.