Are you going through a divorce or separation?
Do you own a small to medium sized business?
Have you ever wondered what your business is worth?
This is a dilemma and question many of our family law clients face. As experienced family lawyers, the valuation of a small or medium sized business when separation or divorce occurs is fraught with difficulties and misconceptions.
This article is intended to explain how businesses are valued when divorce or separation occurs.
Where do we start?
When it comes to property division or settlement, the law makes it clear that all assets are included. Property includes any of the following (but is not limited):
i. Real property such as your home or investment property
The law will also consider ‘financial resources’ when it comes to divorce and property matters. A financial resource is recognized as a financial benefit that a party is likely to receive such as dividends from a trust or an imminent inheritance.
How are small to medium sized businesses valued?
There are typically three methods that are used to value business.
Method 1: the Net Asset way of valuing business
This approach is generally less complex and easier to apply, It involves creating an inventory of the tangible and non-tangible assets (such as a rent roll) and subtracting liabilities to determine the net asset value of a business.
When a business is valued using the net asset method, it is assumed that this business has no positive earnings before interest and tax and no good will. In other words the business basically exists to provide a reasonable salary for an owner and has no value to another potential buyer.
Method 2: the Capitalized Earnings way of valuing business
This method involves using a multiplier approach. This means that the value of a business is based on its future earnings. The value of a business is closely tied to its expected future profits and the valuation is based on assumptions that profits will continue moving forward.
To calculate the value of a business based on capitalized earnings, the following formula is used:
EBITDA (a business’s annual earnings before tax, depreciation, and amortization) multiplied by the market multiple for the sale of comparable businesses.
What is the market multiplier for a business?
This depends on the category of business we are referring to. A recent guide to business transaction and valuations by Groves and Partners (2023) indicates as follows:
i. Accommodation businesses have a multiplier range of 2.0-3.75
ii. Accounting firms have a multiplier range of 0.7-1.3
iii. Advertising, marketing, and PR firms have a multiplier range of 2.0-4.0
iv. Automotive Repair and Maintenance have a multiplier range of 1.5-2.8
v. Building and Construction have a multiplier range of 1.0-2.5
vi. Childcare centers have a have a multiplier range of 2.2-4.4
vii. Consulting businesses have a multiplier range of 0.5-5.5
As can be seen from the sample above, the indicative multipliers show a range of multipliers and a multiplier is influenced by the brand of the business, the technology, the market activity and interest and quality of products and services.
Method 3: the Value to Owner way of valuing a business.
This way is mostly unique and relevant in family law matters. This specific valuation method considers the ‘risk’ of sale from the owner’s perspective. In other words, the multiplier used is influenced by the degree to which the owner desires to retain the business and further what financial (direct and indirect) she or he receives from retaining the business.
The case of Gare and Farlow  is an insightful and informative case on the ‘value to owner’ method of valuing a business when a divorce or separation occurs.
In this case, Judge Forbes explained that the valuation of a business (in the absence of agreement between the separating couple) is a matter for the court and traditional ways of valuing a business will not always be appropriate in family law matters.
Judge Forbes found that in this case, where the wife had been operating her allied health business since the late 90’s and had valued the business at $150,000 in 2002, it was appropriate to adopt the ‘value to owner’ way of valuing this business. It was accepted by Judge Forbes that the ‘value to owner’ to the wife was $429,500.
In this case the multiplier adopted was 2.75 and it was multiplied by the EBITDA of $156.082 gross per annum.
Judge Forbes justified his decision by highlighting the reality of the circumstances as follows:
i. The business had been successfully operating since the late 90’s.
ii. The wife has security of tenancy, because her father owns the premises from where her business operates.
iii. The wife invested in improvements to the business in 2022.
iv. The wife intends to keep and continue to operate her business.
v. The wife gains the benefits of:
– Steady and reliable income
– Flexibility of employment
– Access to and control of business funds
– An ability to tax-plan
– The use of a company car
– Payment of mobile phones
What should you know if you own a business, and you are separated?
1. It is best to obtain an independent and joint expert to value the business.
2. The value to owner method may be relevant depending on whether you wish to retain or sell the business.
3. It is best to mediate and not litigate these matters, because going to court is time consuming and expensive. In the case of Gare and Farlow above, the parties were litigating since 2019 and a decision was made in February 2023.
4. Be honest and forthcoming with your obligation to produce financial disclosure.
5. Ensure you engage the services of a specialist family lawyer who understands business valuations, divorce, separation, and family law.
For more information:
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The information contained herein is general in nature. It does not constitute legal advice. Please contact us for specific legal advice for your situation.