Perception Looks a Lot like Reality in a Divorce Setting:

In a divorce setting when marital property involves a significant closely-held small business, it’s probably advisable that an independent business appraisal be done in order for the parties to make a livable property division. But, even when a valuation by a neutral financial analyst is done, the non-managing spouse can feel uncomfortable with the process as if on the outside looking in. This spouse will often know little about the particular business and even less about business in general and may actually have disinformation.

Equally important is the comfort level of the managing spouse. The non-managing spouse may expect a value for the business that is both unrealistic and unaffordable, especially if the business has been successful and provided a comfortable lifestyle for the couple. Easing the concerns of both parties at the outset of the valuation process and ensuring that anxiety stays low is important to the valuation process.

Toward this end, the couple should be involved with the selection of the valuation neutral so that they are satisfied the neutral will conduct the valuation with impartiality and with an acceptable degree of professionalism. The managing spouse should feel comfortable that “reality-based” will be the front and center by-word in the valuation process and the non-managing spouse should feel less anxious that a financial neutral, not the managing spouse and the company CPA, will drive the process.

First Meeting:

Prior to the first meeting, the analyst should request from the managing spouse, receive and review basic information about the business including, but not limited to, recent financial statements and 3-5 years of tax returns. During the first meeting a clear explanation of the valuation process should be the primary topic. The couple should leave the meeting confident that the valuation process will be visible, competent and affordable and that each spouse will be a key participant in the process. If, at any time, either spouse feels that the analyst should look at an issue, talk to an individual or review one or more documents, that spouse should feel encouraged to communicate that to the analyst.

The valuation analyst should provide a firm fee quote. A flat fee removes cost as source of anxiety and is preferable to an hourly rate. In a collaborative divorce setting, the business valuation fee may be less than one-fourth (1/4th) of the fees in an adversarial context since there is only one valuation not two and since analytical procedures will probably be agreed-upon and limited and less formal documentation required.

If all goes well, the couple should authorize the analyst to draft a neutral valuation agreement, which should document, at a minimum, the key elements:
• the steps in the valuation process
• the fee and terms
• the financially responsible parties
• that if either party chooses to litigate:
o the valuation analyst will terminate services
o the report can not subsequently be used in court
o the analyst will not be available to testify in court
• the valuation process will begin on receipt of a fully signed original of the agreement
• and the advance payment, if any.

Valuations in an Adversarial Context:

The valuation of a business in an adversarial divorce context is similar to a fair market valuation typically found in a business merger/acquisition context. Extensive, and therefore expensive, consideration is required to be given, in either case, to multiple valuation methods and to the reconciliation of all material differences between values arrived at using those methods. Certain basic factors are generally recognized by the business appraisal community to be of particular importance in valuing any small, closely held business.

• Nature and history of the business
• General economic outlook, and specific prospects for the industry
• Net worth and financial condition
• Earnings and cash flow projections as well as dividend paying capacity
• Stock prices of comparable public companies, if any
• Sale(s) of stock in comparable closely-held companies, if any
• Extent of goodwill, if any
• Size of the block of stock being valued, especially if it represents a majority or minority interest
• Whether the stock in question is voting or non-voting
• Limitations or restrictions on the stock, such as on transfer, dividends, etc.

In an adversarial divorce setting, there is almost always a valuation expert for each side. The valuations are subject to disclosure in discovery and it’s considered by many attorneys to be poor practice to not request the opposing party’s valuation and usually take that valuation analyst's deposition.

Collaborative Divorce Valuation is Unique:

In a collaborative setting, however, there is always only one neutral valuation analyst who is engaged by the divorcing parties directly and submits the valuation to the couple and their respective counsel simultaneously. Moreover, the valuation can not be used in court subsequently unless agreed to in writing by all the parties including the analyst. What’s more, new valuation standards now allow the valuation analyst and the client to reduce the cost of the valuation by agreeing to a singe method and limited procedures. This “calculation” engagement will most likely use a standard of value based on “what it’s worth to the managing spouse to own all of the business rather than just his/her marital property half”. It is probably easier to get the spouses to agree on a range of values rather than on a specific value. And, working with this range of value, counsel can more easily facilitate negotiations between the parties.

Second Meeting:

The second meeting is designed to go into much more depth with regard to the history of the business and its growth prospects and the resources it will need to realize that growth. The non-managing spouse may choose to attend or not based on the level of comfort with the analyst and the valuation process. The analyst will consider the existence of non-operating assets and liabilities and any excess/deficient operating assets as well as the extent to which personal, non-business expenses of the divorcing couple have been deducted by the business. In some cases, the valuation analyst may want to review detailed transactions of the business to determine appropriate adjustments. Based on the nature of the business, the valuation analyst would explain the various methods or approaches to valuation and recommend a particular calculation method or approach and obtain the consensus on that approach before ending the meeting.

Third Meeting:

The prospective earning capacity of the business will frequently be the best “calculation” method to use for the valuation and the managing-spouse will need to develop reasonably detailed revenue and expense projections for the analyst to use in the “calculation.” Whatever method is agreed upon, the managing-spouse should bring the requested data to the third meeting and explain to the analyst the assumptions underlying the data. The non-manager spouse may choose to attend or not.

The third meeting should ordinarily be held at the place of business and the analyst should interview company personnel and review enough detailed transactions to be satisfied that the data is appropriate. With the necessary data, the analyst can conduct due diligence, perform the valuation calculation, determine a calculated range of values, and write the preliminary report.

A Preliminary Report before the Final Report:

An important part of maintaining communication with the couple and maintaining a level playing field is the preliminary report. Nothing prevents an analyst from submitting a final report immediately on completion of the work. But, presenting a preliminary report continues the openness that the collaborative team has worked to develop. The preliminary report should be delivered with the proviso that, if either party thinks any element has been over- or under-emphasized, missed altogether or interpreted in error, the analyst should know.

If the analyst is convinced that the observation is legitimate and that correcting the error would make a material difference in the conclusion of value, the analyst will make the appropriate changes before submitting the final valuation report.

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