Business Valuations
The Law Firm of Braselton and Millard believe that the
divorce process requires a multidisciplinary approach. We work with
a range of other professionals.
| Valuing Your Family Business |
VALUING YOUR FAMILY BUSINESS
By Lee A. Gould*, CPA, JD, CFE
Russell Novak & Company, LLP
225 West Illinois Street, Suite 300
Chicago, IL 60610
312-222-1400
lgould@rnco.com
The most valuable assets owned by a family are often the family’s
residence and the business owned by the husband and/or wife. By
law, the business must be valued for divorce purposes. However,
unlike the home, there is no ready market to determine the value
of that business.
The spouse operating the business may tell tales that the business
is unexpectedly souring and the golden days of prosperity are behind.
This mantra is more commonly referred to as Sudden Income Deficiency
Syndrome.
Against this backdrop, the operating spouse may try to convince
you that the value of the business is whatever value is indicated
on the balance sheet of the business. A balance sheet only reports
the assets and liabilities of a company as of the date of purchase
of the asset (net of depreciation) or current amounts the business
owes to its creditors. In addition, the earnings that these assets
generate do not increase the value of these assets.
This method is not a good indicator of value for companies
that sell consulting, medical, dental and legal services, among
others. For example, imagine that your spouse owns a professional
recruiting firm that places sales representatives. The assets of
the company consist of four computers, a computer network and office
equipment (desk, chairs and phone system). Total out of pocket investment
$40,000. This modest investment generates $1 million in annual revenue
and your spouse earns $250,000. If the value of the business was
based on the balance sheet, it would only be valued at $40,000 (assuming
no liabilities) for divorce purposes.
A business valuation doesn’t begin or end with the balance
sheet. Estimating or arriving at a value for a company (or a fractional
ownership interest in a company) begins with a detailed analysis
of the company. In order to determine the value of the business,
the valuator must learn about the strengths and weaknesses that
the spouse operating the business already understands. It is only
then that the value of the business can be determined.
Businesses can be valued by other methods that are based on current
or future income generating capabilities of the business. One such
method uses normalized historical earnings (i.e. earnings expected
to continue into the future adjusted for items such as excess owners
compensation and personal expenses charged to the business) to derive
a value for the business. The normalized earnings are converted
into an indication of value for the company using a capitalization
rate that incorporates the risks associated with the business in
generating its future earnings. Capitalization rates vary among
particular types of businesses and from time to time.
The capitalization rate can be presented as a percentage or a multiple.
A capitalization rate of 25 percent is a four times multiple. Therefore,
the more uncertain the business’ income stream, the higher
the capitalization rate is (and the lower the multiple) which serves
to lower the value of the business.
If the normalized earnings stream of the hypothetical recruiting
firm is $250,000 and the capitalization rate is 25 percent, the
value of the business is $1 million ($250,000 x 4) and not the $40,000
indicated on the balance sheet.
Don’t give away your assets unknowingly. It is very important
for you to hire an experienced business appraiser to protect your
interest in the business.
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Lee A. Gould is a Certified Public Accountant
and Certified Fraud Examiner who specializes in the valuation
of closely held businesses, financial damage determination
and forensic accounting investigations. He performs business
valuations for matrimonial dissolution proceedings, estate
and gift tax purposes, shareholder dissent and oppression
actions and buy/sell agreements. Lee also performs forensic
accounting analyses to assist in locating unreported or hidden
assets and investigate claims of dissipation.
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