Businesses raise particularly difficult questions in divorce. Of course, if a husband and wife have been actively involved in running a business together, and both own shares of it there is no reason in theory why they should not continue to do that after they separate and divorce. But from a business perspective that is probably not going to work, and in the vast majority of instances one person is more actively involved in the business, and will wish to continue to operate it into the future.
If you become involved in court proceedings, the judge will almost always want to take the business into account in dividing out assets, so most people want to bring it into the equation in a negotiated settlement.
There are really two aspects to the problem. Firstly the business, or rather the husband/wife’s interest in the business (because there may be other people involved in the business – business partners etc) has to be valued. Secondly once the value is established, money needs to be found from either from inside the business, or from somewhere else in the husband and wife’s assets, to take account of the value. Unless, of course, it is to be sold, which is generally not the preferred outcome.
How are businesses valued for divorce?
So the first issue is to value the business. Put simply, the fundamental question is, “How much could this business be sold for?” but it is not an easy question to answer.
Many people have a reasonably well-informed opinion about the value of their home, and other investments and savings, but when it comes to the value of a business, they really have no clue, so they have nowhere to start. Large companies and PLCs are relatively easy to value, because their shares have a quoted value on the stock exchange, but that does not apply in small and medium-size businesses. Often they are very specialist in what they do, so there may be only a small pool of potential buyers, and no comparable transactions in recent times, to give an idea. So the value is difficult to determine and ultimately involves an element of speculation.
It is understandably very difficult for a separating husband and wife to reach any kind of shared opinion about this, the more so if one of them has been more actively involved in running the business than the other. That person probably has the best idea of where it stands, and he or she is also very aware of the risks and challenges it faces, but understandably (and perhaps correctly) s/he may be quite gloomy about the prospect of ever selling it or what price it might achieve, particularly as her/his life is thrown into turmoil by divorce . The person who has been less involved in the business really has no information on which to base an opinion about its value, and is probably inclined to treat gloomy predictions with a degree of scepticism.
So the law looks for an independent opinion about the value of the business. In practice an accountant is instructed jointly by the parties’ solicitors to produce an opinion. This accountant will be entirely independent of the business and the business’s own accountants and is known as a “single joint expert”. Most large and medium-size accountancy firms will include one or two people who offer this service which they call “forensic accountancy”. The choice of forensic accountant, the information s/he is given, and the terms of reference are all critical, and you need support from a solicitor who is an experienced expert in this area of family law and divorce to guide you through the process.
The forensic accountant’s approach to valuing the business will vary from case to case. In some instances s/he will be interested primarily in the value of the business’s assets – that might be appropriate, for example, in a company which specialises in acquiring and selling properties. But in the majority of cases, the value of the business is not really in the assets it holds, but in its scope to generate profits in the future. So although the forensic accountant will usually want to visit the business at least once, s/he will focus primarily on the accounts. Broadly speaking s/he will look back over previous years and from that try to identify what profit the business can reasonably be expected to make in the coming years. This is referred to as the “sustainable profit” and it is assumed that this would form the basis of any offer a person interested in buying the business would make. In reaching that figure the forensic accountant may make various adjustments. For example if the work of the business owner is key to its profitability, then the accountant will make some deduction, on the basis that a subsequent owner would have to employ someone to undertake some or all of those tasks, which would be an additional expense and so reduce the profit. For some small and medium-sized businesses that will make a significant difference to the sustainable profit, and therefore ultimately to the accountant’s opinion as to the business’ value.
Once the forensic accountant has established a figure for the sustainable profit he or she will apply a “multiplier” of a number of years to reach his/her provisional opinion as to the value of the business. S/he may then make various other adjustments before arriving at a final figure. Obviously if the person only owns a percentage of the total business, say 30%, then his/her share is only worth 30% of the total value of the business. But also, where the shareholding is comparatively small, the value will be reduced again to reflect the fact that the shareholding does not bring control over the business, and therefore would not be of particular interest to a potential buyer. The forensic accountant will put all of this into a report.
You will appreciate from the above explanation that the valuation involves a large element of opinion. The husband and wife both have opportunity to put written questions to the forensic accountant after they have seen his/her report, which provides an opportunity to challenge aspects of his/her opinion. You are likely to need guidance from a solicitor who specialises in this aspect of divorce and family law, to identify and frame the right questions. Because of the very technical nature of the forensic accountant’s task, we sometimes engage a second accountant to comment on the report and assist us with that process. These people are known as “shadow experts”.
Ultimately the forensic accountant’s opinion involves an element of speculation. Two different forensic accountants would probably have two different opinions about the value of any particular business, although hopefully they would be reasonably consistent and not too far apart. If you receive a forensic accountants valuation which you’re not happy with it is tempting to try to commission another. Unfortunately there is very limited scope for that, partly because the process is expensive, and partly because, in the courts valuation evidence can only be produced with the permission of the judge. Judges do not want the parties to get involved in the expense of producing multiple reports, so they will generally not allow these opportunities to introduce a second opinion.
How is the value of a business taken into account in a divorce settlement?
At the end of the day, for families whose financial settlements are determined by the court, this is a question for the judge’s discretion, and there is no definite answer. Generally speaking most judges will assume that the value of the business should be shared equally within the terms of the overall settlement but there are a number of problems with that. For example it may not be possible to share the value equally without selling the business itself, which is generally not the preferred outcome, because it is likely to continue to be the families source of income into the future. And it is recognised that the value of a business is ultimately speculative, and also that it can go up or down, so that it is perhaps not fair to compare it precisely with the value of what are sometimes called ‘copper bottomed’ assets like money in the bank or a house. Thirdly the court has to recognise that selling a business, or extracting money from it, is likely to result in tax liabilities, which have to be taken into account in the overall picture.
So often once the value of the business has been established it gets taken into account at a reduced level within the overall settlement, or the person wishing to keep the business is given time to pay, resulting in some sort of deferred payment or a staged payment.
But these issues are complex, and small differences of approach to the issue, or the way in which the expert is instructed to value the business can result in significant differences in outcome. So, if you are facing a divorce, and you or your husband/wife own a business, you need to get advice from an expert family law solicitor who specialises in this area.
John Pratley is an expert divorce lawyer, who has more than 25 years experience advising clients purely about divorce and related family law issues, such as the financial consequences of separating and divorcing. After establishing the first niche family law practice in Bristol, and going on to senior management roles in a national firm, John set up Apple Tree Family Law in 2018. Apple tree family Law solicitors specialise in advice about divorce and financial issues.
We are based in Bristol and Exeter, but we have clients all over the UK and further afield. We offer, simply, clear and accurate advice about divorce and family law issues, and the very best client service, for a clear and reasonable price.