A recurring theme in divorce cases involving interests in a business is that where there is a business, there is likely to be a disagreement about what it is worth. Therefore, business valuations in divorce are a very popular talking point.
The reasons for disagreements around valuations are many and varied and often depend on the type of business and whether the parties own it jointly or not.
Why business valuations in divorce cause disputes
If only one party owns the shares in a limited company, the other will feel vulnerable and determined to ensure they receive their fair share. Often, the non-owning spouse has played a role in the business, perhaps in setting it up or, as an employee, or by being appointed the company secretary.
Often, the functions of the company secretary are discharged by third parties, such as the company’s accountants, but appointing a spouse as the company secretary enables the couple to manage their financial affairs by being remunerated in the most tax-efficient way.
It is often the ability to extract funds from the business and the future maintainable earnings from the business that is at the heart of the dispute. Not only is the ability of the business to generate income relevant to the value of the business, but this will also directly influence other issues, such as the appropriate level of maintenance. The business is often the goose that lays the golden egg, enabling the family to fund their lifestyle. Determining how the business should be shared post-divorce can be incredibly difficult and often acrimonious.
Getting the business valued during divorce
Faced with the above issues, the court’s approach will be to direct that a single joint expert be appointed to value the business. The question for the valuer to consider is what would a willing buyer be prepared to pay for the company as a going concern.
Business valuation process
The business valuation process for divorce includes an evaluation of the future maintainable earnings of the business and the ability of the business to generate funds to meet the claims of the non-owning spouse without affecting its future viability. Allowances are also made for tax and the costs of disposal to arrive at a net figure.
The most common methods used are the capitalised future maintainable earning method and the net assets method. Valuing a business on an earnings basis involves calculating the amount of earnings, often in the form of turnover, EBITDA or post-tax profits, which the company can sustain for the foreseeable future.
A multiplier is then applied, representing the number of future earnings that a potential purchaser might consider acquiring. A valuation on a net assets basis values the assets in the business, less the liabilities of that business, either as a going concern or on a breakup basis.
This assumes that the assets must be sold immediately. Again, a net figure is arrived at after tax and selling costs are taken into account.
The valuation of any business is inherently risky, and the decided cases provide useful guidance. For example:
H v H [2008] 2 FLR 2092 (Moylan J):
“The purpose of valuations, when required, is to assist the court in testing the fairness of the proposed outcome. It is not to ensure mathematical/accounting accuracy, which is invariably no more than a chimera. Further, to seek to construct the whole edifice of an award on a business valuation which is no more than a broad, or even very broad, guide is to risk creating an edifice which is unsound and, hence, likely to be unfair. In my experience, valuations of shares in private companies are among the most fragile valuations which can be obtained.”
Chai v Peng [2018] 1 FLR 248 (Bodey J):
‘It is a familiar approach to depart from equality of outcome where one party (usually the wife) is to receive cash, while the other party (usually the husband) is to retain the illiquid business assets with all the risks (and possible advantages) involved.’
In Chai v Peng, the wife received 40% of the ‘kitty’ to reflect this fact. These observations apply forcefully where a business has been valued on an Earnings Basis but less so when businesses are valued on a Net Assets Basis, which is regarded as more reliable. A phrase often used is that valuation is more art than science.
Challenging business valuations in divorce
Given the broad range possible in business valuations, it is perhaps unsurprising that one of the spouses may be disappointed with the conclusions of a single joint expert. In those circ*mstances, it is sometimes possible to argue for the instruction of a second expert and to rely on their evidence – a so-called “Daniels v Walker” application. These are not straightforward applications, and the basis of the application must be more than peripheral or” fanciful” to use the court’s expression.
There is limited case law on the subject, but the following principles set out in Bulic v Harwoods & Ors [2012] are relevant when the court is deciding whether or not to grant the application:
- ‘What represents justice between the parties will very much depend upon the facts of each case’.
- ‘the saving of time and money is likely to assume greater significance in inverse proportion to the centrality of the issues’.
- ‘Where the court is concerned with a relatively “peripheral” issue, it is likely to be only in unusual circ*mstances that the services of a single joint expert will be dispensed with’.
- ‘the court is less likely to be ready to dispense with a single joint expert where the evidence is of a non-technical nature’.
Handling business valuations in divorce – final thoughts
In summary, a disagreement regarding the single joint expert’s opinion on a business evaluations in divorce will not usually be enough to succeed in a Daniels v Walker application. Normally, technical reasons will be required, which in itself will involve working with a shadow expert in the background to consider carefully any shortcomings in the single joint expert’s report and the reasons for arriving at their conclusions.
If the application is successful, the court is also likely to give directions for the single joint expert to meet the proposed new expert with a view to narrowing the issues between the parties and saving costs.
If no agreement can be reached between the experts, they may both be directed to attend court and give evidence.
When it comes to business evaluations in divorce, the arguments are technical and complicated as the stakes can be high for each of the parties. Differences in valuations can sometimes mean a difference in the millions of pounds, and the business is often the most valuable asset in the case.
The costs of obtaining expert evidence can be very high, with fees of c.£10,000 not uncommon, so this will only be appropriate in cases where the values of the assets in the case are proportionate to the costs incurred.
A poorly drafted application is likely to result in an order for costs being made against the unsuccessful party. It is essential that expert advice is taken as soon as possible from an experienced team.
Here at Watson Morris, we are adept at dealing with these issues. If you are working through business evaluations during a divorce, then contact us today for expert legal advice.
Peter Morris
