Valuation methodologies differ depending on the type of business
The Family Court employs the following organized methods of valuation of a business for property settlement purposes:
1. Capitalization of estimated future maintainable dividends
This methodology is appropriate for valuing a minority interest in a business. A person with a minority interest in a business has no control or influence power but has the right to receive dividends. This methodology is not frequently applied to the valuation of shares in private companies because private companies invariably have inconsistent earning patterns which are often affected by tax consequences. If this methodology is applied it must be with a business which has earnings that have been relatively consistent over the years.
2. Net present value of future earnings
This methodology is appropriate for businesses that allow for fluctuations in the future performance of the business and those that have a known lifespan like if it has a fixed term contract. To put it simply, this methodology reduces the future amount of income by taking into account inflation in order to obtain the present worth of the business in dollars.
The value of the business that is derived is the total of all future income that the business will produce in today’s dollars. To be able to determine the present worth of the income of the business, a reliable cash flow projection is required. For smaller business, a cash flow projection beyond 12 months is usually not prepared. The discount in cash flow approach is not generally applied in family law property settlement proceedings.
3. Capitalization of future maintainable earnings
This method is appropriate in valuing a controlling interest in an ongoing business. The business must have a history of consistent income from which future profit can be based. The methodology requires a determination of the future maintainable earnings of the business and consideration of the factors that would most likely affect the future operation of the business; identification of profits and losses that arise from a surplus of assets; and selection of appropriate earning multiple with regard to the market rating of comparable businesses.
4. Net asset backing
This methodology is used where a business is not making profits or the cash flow yield is less than that which could be earned if the assets of the business were sold and the proceeds of the sale is invested. The value of the business is simply the result of all the assets added and the liabilities deducted. The assets should be valued as if they were disposed in an orderly fashion and not as if in a fire sale.
1. A single expert valuer is required to consider each of the abovementioned methodologies and adopt that which will provide the highest result as being the appropriate value for the business.
2. Industry bench marks are not controlling. They can be utilized, however, to cross check the accuracy of the methodologies.
3. In valuing goodwill, a distinction must be drawn between valuing personal goodwill and business goodwill. Personal goodwill pertains to the result of know-how and contract which follows a business owner while business goodwill pertains contracts, methodology and reputation which follows the business instead of the owner. In small business which involves only a single person, personal goodwill often does not have significant market value.
4. Tax consequences of a sale.
5. Effect of loan accounts within a business.
Disclaimer : This article provides basic information only and is not a substitute for a professional or legal advice. It is prudent to obtain legal advice from a family lawyer.