In divorce, valuing the business in isolation may cause you to miss key financial information. A comprehensive, 360-degree approach could yield radically different – and more accurate – results.
By Stacy A. Statkus, Business Valuator and Litigation Expert
You have hired a firm to do a business valuation for divorce purposes. The valuator requires documents related to that business: financial statements, tax returns, shareholder agreements, etc. But what about other financial documents and information – such as marital assets, liabilities, and lifestyle? They could be very relevant to the case.
Imagine a business for which the tax returns show consistent net income of $100,000 to $125,000 per year. However, the financial disclosures filed by each of the parties show a lifestyle of significantly more than that (after tax). This will likely prompt a series of questions:
- Is the other spouse working?
- Are the parties receiving gifts from family members to help support the lifestyle (e.g., monetary gifts and/or payment of certain expenses such as private school tuition, summer camp, etc.)?
- Do the parties have significant passive income from other assets (whether marital or separate)?
- Are the parties borrowing money or selling assets in order to fund the marital lifestyle?
You may require a forensic analysis in order to determine the parties’ true lifestyle, the sources of income and the expenses being paid (as well as the sources of funds used for those expenses). Depending upon the case, the analysis may be limited or more extensive in scope. You may discover that certain items are regularly being paid in cash and/or certain personal expenses are being paid through the business.
The Financial Aspects of Divorce: Personal vs. Business Expenses
Normalization of expenses is customary in a business valuation; however, without understanding the whole picture, you may not realize that the house-keeper for the parties’ residence is being paid through the business payroll, the real estate taxes are included in business expenses, and the utilities paid by the business are for the residence as well as the company. These are just a few examples of such expenses.
The non-titled spouse may be an unreliable source of information about how business and personal expenses are funded and paid. They know their lifestyle is paid for, but not necessarily whether expenses are paid in cash, through a personal checking or credit card account, or through a business checking or credit card account.
Consider a business that does home building and/or construction. Many expenses for the parties’ residence may be run through the business, but finding them may require further exploration. For example, the non-titled spouse knows that they did a significant remodel of the home in a certain year, but the parties’ personal checking and credit card statements for that time show no payments for renovation expenses and no significant changes in cash withdrawals. Unless you can trace the funds to a gift or bequest, then the expenses were probably paid by the business. Or you may notice that all of the building materials for the business are ordered from vendors in “Area A.” The parties’ residence is in “Area B,” and during the remodel, the business placed significant orders with vendors in Area B. If this does not fit the company’s normal pattern, then those Area B orders were likely for projects related to the residence.
Alternatively, there may be artwork hanging in the family home, but it does not appear on the personal net worth statement of either party. When one spouse questions why it was excluded, the other spouse states that it is owned by the business. However, it was not significant enough to be listed on the financials of the business; instead, it is included in “other assets.” As such, an adjustment may be warranted for non-operating assets.
These are just some examples of ways in which it may be useful to have a more holistic understanding of the financial aspects of a case where a business is involved.
Stacy Statkus, CVA, CDFA, CFE, JD is a Senior Vice President with MPI. She has more than 16 years of experience in litigation consulting, forensic analysis, and business valuation. Her areas of expertise include matrimonial litigation involving high-net-worth individuals. www.mpival.com
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