When a business is a marital asset involved in a Pennsylvania divorce proceeding, it may be necessary to determine its value for equitable distribution. Business valuation is a sophisticated process which often requires the skill of professionals to analyze financial data, apply recognized valuation techniques, develop expert opinions concerning value, and support those opinions during court hearings or settlement negotiations. Some businesses do not have to be valued, but it may require an experienced family lawyer (and sometimes an accounting expert) to know the difference. At Pollock Begg Komar Glasser & Vertz LLC, we have represented business owners and their spouses and worked with both the company’s own accountants and expert witnesses who may testify effectively in court proceedings.
What is business valuation or a company appraisal?
Business valuation is a process applied by qualified valuation experts to determine the value of an owner’s interest in a business. Three different approaches are commonly used in business valuation: the asset-based approach, the income approach and the market approach. Within each of these approaches there are various techniques for determining the fair market value of a business.
- The asset-based approach is perhaps the simplest method. By adding up the values of the assets and subtracting liabilities, the expert may determine the book value or net asset value of a business. It may be necessary to adjust the historical cost value of the assets shown on a balance sheet to their actual value.
- The income approach determines value by calculating the net present value of the cash flow generated by the business. The appraiser might adjust the company’s profit and loss statement before applying an appropriate capitalization or discount rate.
- The market approaches determine value by comparing the subject company to other companies in the same industry, of the same size and/or within the same region.
Most treatises and court decisions encourage the valuator to consider more than one technique, which must be reconciled with each other to arrive at a value conclusion.
What is normalization of financial statements?
Generally, the first step in business valuation is normalization of the company’s financial statements. Normalizing the company’s financial statements permits the valuation expert to compare the subject company to other businesses and detect trends and irregularities. Appraisers may adjust the owner’s compensation and benefits to reasonable levels, add back non-cash expenses like depreciation, and adjust nonrecurring income and expenses. These are judgment calls that are frequently made by expert witnesses who testify in divorce cases that require business valuation. Typically, the owner and the company’s own accountant may be viewed as having bias, so the courts rely on experts to make the appropriate adjustments to the profit and loss statement.
How is the capitalization of earnings method used?
In Pennsylvania divorce litigation, many business valuations are based on the capitalization of earnings method. The capitalization of earnings method calculates business value by first normalizing the profit and loss statement to determine the profit a hypothetical buyer would generate after the sale. Next, the appraiser determines what level of investment return the hypothetical buyer would demand for a particular type of business. Since private businesses are more risky than government bonds, blue chip stocks or even most penny stocks, investors generally demand a higher return for private companies than any of these other investments. With normalized earnings and capitalization rate, the appraiser can predict the price that a hypothetical buyer would pay to buy the business. Next, the appraiser may apply discounts if there is no ready market (such as NYSE or NASDAQ) for private company stocks and/or because the owner holds a minority interest in the business.
When a business is involved in the owner’s divorce, the stakes may be high. Having experienced counsel who are familiar with business valuation techniques can be an advantage. The lawyers of Pollock Begg have handled numerous divorces involving business valuation and understand the issues.