If one or both parties own a business, and an agreement on its value cannot be reached, a business valuation will usually be ordered. There are many aspects of the business that valuators analyze and clients sometimes do not understand the method to the madness, so to speak. The following is an explanation of the two more common valuation misunderstandings.
- Normalization adjustments: Normalizing the historical earnings is a necessary step in the valuation process. Sometimes, during the most recent year prior to the divorce, an extraordinary or non-recurring expense has hit the business and effected profits. Normalization adjustments are then made to remove extraordinary or non-recurring items (be it income or expense) from the historical earnings. The valuation expert’s role is to adjust historical earnings to represent to a reasonable degree of certainty the economic reality of an ongoing business.
- Motivation of the owner: Many businesses experience cyclical patterns of income, while others follow a continuing growth pattern. The pattern of the business’ profits for many years prior to the divorce are an important indication of future earning potential. However, sometimes during or right before a divorce, profits fall drastically. It could be that the owner is intentionally devaluing his/her business, but it could also be that due to the pending divorce, the business owner’s motivation to sell dropped. The owner may not be spending as much time at work in an attempt to save his marriage or he/she may be experiencing some emotional issues. In either case, a drop in profits immediately preceding the divorce is not always caused by bad faith.
If you do anticipate needing a business valuation, you should retain an expert early. The valuator will need to review many documents and discovery prior to the actual report being furnished may be extensive.