Valuing a business during divorce proceedings can be a challenging and intricate process. Business valuations in this context require careful consideration of unique factors such as company-specific risks, historical financial performance, officer compensation, and discretionary expenses. Accurately projecting future earnings, while accounting for normalization adjustments, is also critical to arriving at a fair and defensible business valuation.
Advisory professionals often play a crucial role in guiding divorcing couples through this process, ensuring that the valuation reflects the business’s true worth. This article explores some of the key considerations that impact divorce-related business valuations and provides insights into the factors that shape the final valuation.
Company-Specific Risk
Assessing company-specific risks is one of the first steps in valuing a business for divorce purposes. Several factors can influence a business’s risk profile, including:
- Length of operation: How long has the company been in business?
- Customer base concentration: Does the company rely heavily on a few key clients?
- Owner involvement: How integral is the owner or shareholder to the company’s operations?
For example, if a company derives 50% of its revenue from a small number of clients, the loss of even one or two could significantly impact future earnings. Quantifying this risk is essential in determining the business’s overall value.
Years to Analyze
When analyzing a business’s financials for valuation, it is common to review three to five years of historical data to capture trends and normalize any unusual figures. However, in cases where a significant event—such as a merger, acquisition, or economic downturn—has occurred, adjustments may be needed to include additional or fewer years.
The goal is to present a fair and accurate representation of the business’s performance over time, which can sometimes involve extending the period of analysis or isolating specific events.
Officer Compensation
Officer compensation can become a contentious issue in divorce-related valuations. High officer compensation can lower the business’s apparent value, especially if compensation levels are significantly above industry norms or do not align with the business’s performance.
In Massachusetts, for example, the higher the officer compensation, the lower the business value due to the expense being factored in. In cases where an officer owns 100% of the business, determining compensation is more straightforward. However, in instances where there are multiple owners and one is going through a divorce, the situation becomes more complex, requiring adjustments to account for the divorcing spouse’s share.
Projections
Projections are critical in valuing a business for divorce purposes, but they must be realistic and based on solid evidence. Factors such as historical company growth, industry trends, and future market conditions all play a role in creating reliable projections.
In some cases, business owners may provide overly optimistic projections. Here, analysts may adjust for more conservative estimates or perform a sensitivity analysis to account for multiple scenarios. This is particularly important for smaller companies or startups, where growth can be volatile and difficult to forecast. Running projections over a 4-5 year period can help stabilize the valuation, especially if the company is in its early stages of rapid growth.
Discretionary Expenses
Distinguishing between necessary and discretionary expenses is another important step in the valuation process. Personal expenses disguised as business costs—such as excessive travel, meals, or personal car use—can distort the company’s financials and affect the valuation.
Advisory professionals closely scrutinize expenses and adjust for personal or non-business-related items. For example, if a business owner purchases a $100,000 car for personal use under the business’s name, this expense should be added back to the owner’s income as a non-operating asset.
Naviating Financial Intricacies
The process of valuing a business during divorce requires a comprehensive understanding of financial intricacies and careful attention to unique, business-specific factors. Every element, from company-specific risks to officer compensation and discretionary expenses, plays a critical role in determining the final valuation.
Advisory professionals provide invaluable insights and experience in the business valuation process, ensuring that the final valuation is fair, balanced, and thoroughly supported by data. Their expertise helps both parties in a divorce achieve a fair outcome, allowing for clearer decision-making and smoother negotiations.
Get the Right Guidance
If you’re facing a business valuation due to a divorce, partnering with an experienced advisory team can help you navigate this complex process with confidence. Our professionals are here to guide you through the critical considerations and ensure your business’s value is accurately reflected.
Contact our team today to learn how we can assist you in achieving a fair and equitable resolution.
