In Part 1 of our two-part blog on the impact of businesses and business valuations in high-asset divorces, we talked about its complexities and importance. We discussed the three basic methods of valuating businesses.
Here, we will revisit the three methods and discuss why and where they may work best. We will also take a look at the practice of valuating businesses using discounts under certain ownership situations.
The income approach to a business valuation is perhaps the most complex. It also just happens to be the most popular way of valuing a business in a high asset divorce. The income approach itself can use two methodologies. Both use earnings rather than cash flow or profits to estimate projected future earnings.
The capitalization of earnings method is generally used by stable companies with strong and consistent earnings histories. Slow and steady growth is usually used in anticipation of future earnings.
The discounting cash flow method is used when future earnings are less predictable.
While it uses past performance, it also employs discounting the business based on whether the business may be quickly sold or if a key man, like the current owner, may no longer be with the company. This is often the case in skilled trades like plumbing, HVAC, and electrical, where the owner may be the key employee. It also can apply to professional practices like dentists’ and lawyers’ offices.
The market approach is extremely valuable where there are plenty of similar businesses that may have recently sold. Coffee shops in Seattle, for example, or souvenir shops in Daytona or Myrtle Beach. The market approach uses a more real-world approach but is not applicable to all businesses, especially unique ones.
The asset approach uses a company’s physical assets against its debts to determine a net asset value. This approach is usually only used when other methods won’t work, aren’t applicable, or the business is struggling to generate cash flow.
Discounts in Business Valuations
In a 2007 Massachusetts Supreme Judicial Court case, Bernier v. Bernier, the court made a landmark decision impacting valuators of businesses, attorneys, and couples involved in high-asset divorces. The main holding of the case essentially says valuators are prevented from using certain “discounts” in valuating businesses that the owner does not intend to sell in the short term.
For years previously, valuators were allowed to discount such companies for minority shareholders, including spouses of owners or principals of such ongoing businesses.
Marketability discounts were also impacted by the ruling which said that a spouse’s ability to sell minority shares should not lessen their value. The ruling included “key man” discounts, saying that a company’s value could not be discounted if the spouse were the “key man” in the business, unless his departure from the business was imminent.
The consequence of Bernier is that restrictions on discounts have essentially increased business valuations.
Business valuations are a vital part of high-value divorces where company ownership by spouses is in play. It is yet another reason why competent, experienced legal and accounting assistance is vital.
This is not the time to retain the least expensive representation. Contact us today to discuss and professionally assess your situation.
If you have questions about a prenup agreement or a postnup agreement or require legal assistance in other areas of Family Law such as high asset divorce you may always contact Damien McKinney of The McKinney Law Group to discuss your case further. He can be reached by phone at 813-428-3400 or by e-mail at [email protected].
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