Advice from 6 valuators on dealing with divorce-related business valuation issues.
Normalizing the Historical Earnings Is a Necessary Step in the Valuation Process
During a business valuation, normalization adjustments to extraordinary or non-recurring items are made to remove one-time and/or non-recurring income, and/or expense items from the historical earnings.
In our experience, certain attorneys do not fully understand why a valuation expert adjusts for these types of expenses. An extraordinary or non-recurring expense is an actual expense incurred by a company, but is not an expense that will be an ongoing expense. Given that the company actually incurred the expense, an attorney can have a difficult time with the “add back”.
It is important to understand that normalizing the historical earnings is a necessary step in the valuation process. When a company has a year with an extraordinary or non-recurring expense incurred, the historical earnings may not represent normalized earnings potential. The valuation expert’s role is to adjust historical earnings to reasonably represent the economic reality of an ongoing business.
– Michael A. Saccomanno (CPA, ABV,CFF, CVA, CDFA™), Friedman LLP,
The Business is Struggling at the Time of the Divorce: Is this Real or Just a Game?
Businesses can be cyclical, or they can follow a unique growth pattern based on their own specific circumstances. A historical qualitative and quantitative analysis of a business’s operating results can provide some explanation as to why the company may be experiencing a particular down cycle as of the valuation date. For small businesses that are more reliant on the efforts of the owner, the impact of the divorce itself must be considered. Is the indicated downturn in the business due to a distracted owner? Or could the downturn actually be premeditated in an effort to devalue the business during the proceedings?
Specifically for businesses with cash accounting, a detailed analysis of the timing of invoicing and payments must be considered, as the owner may be intentionally delaying income that might make the business appear more valuable than they desire. Overall, the appraiser must be aware that the downturn may be related to the divorce itself, and take appropriate care both qualitatively and quantitatively in determining the value of the business.
– Arik K.Van Zandt (ASA, CDBV), Senior Director, Alvarez and Marsal, www.alvarezandmarsal.com
Celebrity Goodwill and the Right of Publicity
With recent cases in California and the change in the law in New York, many believe that the concept of celebrity goodwill is gone. (It still exists in New Jersey.) What is often overlooked in the celebrity goodwill discussion is the right of publicity (RoP). RoP is narrower than the concept of celebrity goodwill, and it is alive and well.
Recent controversy over the value of Michael Jackson’s name and likeness in connection with his estate has highlighted the issue of the commercial exploitation of an individual’s name and likeness. This is not a new concept: there is a legion of litigated cases involving the unauthorized use of a celebrity’s name and likeness.
RoP is often defined as an individual’s right to control and profit from the commercial use of his/her name, likeness, and persona. It is the alter ego of the Right of Privacy. RoP in the United States is governed by state law, so it is important to understand the protections afforded this right in any particular state.
Celebrities often license the use of their name, likeness, or persona in connection with a product endorsement. We are all familiar with George Foreman’s grill and, if you are old enough to remember, Joe DiMaggio’s endorsement of Mr. Coffee. One change that has occurred in recent years is the outright sale of a celebrity’s name and likeness. This includes the aforementioned George Foreman – but more recently, Marilyn Monroe and Muhammad Ali.
As the proliferation of reality TV attests, America’s love of celebrity continues unabated. So if the circumstances arise, do not overlook the right of publicity.
– Jay Fishman (FASA), Managing Director, Financial Research Associates, www.finresearch.com
5 Quick Tips from the Trenches
Start Early: A business valuation analyst needs to be brought in early in the case to help with identification of information and documents during the discovery process. Sufficient and reliable data is needed for correct valuation results. Business appraisers have comprehensive lists of documents that are needed in a valuation, and they contain more than just financial statements and tax returns.
Credentialed Appraiser: Hire the best appraiser your client can afford, and make sure he or she is credentialed. The valuation credentials come from the following organizations: American Society of Appraisers (ASA), American Institute of Certified Public Accountants (AICPA), Institute of Business Appraisers (IBA), and National Association of Certified Valuation Analysts (NACVA). Credentialed experts have to follow professional business valuation standards.
Keep Your Expert in The Loop: After retaining a business appraiser, keep him or her informed in the developments in the case; attempts to settle, depositions, relevant dates, and deadlines – and if such dates are pushed, because there may be conflicts in the appraiser’s schedule.
Settlement Help: If the report of the opposing party’s expert is available early in the process, a review and critique of that report by your expert may help in negotiations to settle the case. If the report is reasonable, then your client may benefit from settling the case early and save resources.
Prepare for Testimony: Work with your appraiser to make sure that you are on the same page regarding the important facts of the case. Not being informed about key aspects in the case may make the appraiser appear unprepared and lose credibility. Communicate with your expert and prepare accordingly.
– Shannon Pratt (CFA, FASA, ARM, ABAR, MCBC, CM&AA) and Alina Niculita (CFA, ASA,MBA), Shannon Pratt Valuations, www.shannonpratt.com
Valuation Disputes in a Divorce Setting Should Settle Out of Court
One never knows what will happen if a valuation dispute goes to court. In a matter a few years ago, I was the business valuation expert for an attorney on behalf of the husband. He and his wife owned a successful business, 50% each. For reasons I still don’t understand, he had operational control and fired her. He wanted to purchase her stock, and she wanted to purchase his. I valued the business at approximately $50 million, and the opposing expert valued it at $80 million. We went to court and both experts testified. I like to think I was most reasonable and persuasive, but we will never know.
The judge ruled that the couple had proven beyond any doubt that they could not and would not work together. He refused to rule on a situation where the husband would purchase the wife’s stock, and similarly he refused to allow the wife to purchase the husband’s stock. It was apparent that no transaction could occur without significant seller financing. The judge refused to rule on an option that would prolong their long-embattled relationship financially. He ruled that the company would have to be sold, with the net proceeds to be split between the parties. Both sides spent tons of money on the valuation dispute and the result was what they should have agreed to when they decided to divorce.
– Z. Christopher Mercer (ASA, CFA, ABAR), Founder & CEO of Mercer Capital, www.mercercapital.com
Managing Client Expectations
In our practice, we’ve often found that when a divorcing spouse has strong opinions about the value of their business (or the value of their spouse’s business), they have a difficult time accepting results that don’t meet their preconceived notions. This can sometimes lead to prolonged conflict, requests for second (or third) valuations, and a change of lawyer.
Most people aren’t terribly familiar with the principles of valuation, how valuations are carried out, and why experts are needed to perform them. A valuation is a dispassionate assessment of what a potential buyer would pay for a particular business based on long-standing accounting and financial principles.
In contrast, a divorce can be one of the most emotional and upsetting ordeals that a person will ever have to go through. That’s why it’s so important that family law professionals spend some time educating their clients about the valuation process: clients need to know that neither a private settlement nor one handed down by the courts will award equalization based on “gut feeling”, but on expert opinion.
– Matthew Krofchick (CPA, CMA, CBV, CMC, CFF), Krofchick Valuations, www.krofchickvaluations.com
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