Posts Tagged ‘divorce’

Neutral business valuation is typically part of any Collaborative divorce, and has a number of important advantages over each spouse hiring his or her own expert, including:

  1. Much less costly.
  2. Assuming the manager-spouse provides the necessary data on time, much faster.
  3. In a Collaborative divorce, the objective is to deliver an opinion on which the spouses can agree, understand, and believe is fair. Therefore, there is no need to “defend” the firm’s opinion from withering cross-examination.
  4. Instead of the ill feelings that inevitably flow from an adversarial valuation process, a neutral process can provide the basis for a more collaborative atmosphere for the resolution of other financial and, even, non-financial issues.  After all, if the couple can come to an agreement on a nettlesome problem like the value of the business, they should have a good shot at successfully negotiating other matters.

Effective Referrals

Relative unfamiliarity with the specific business in question, and with financial matters in general, will typically cause the non-manager spouse to fear that s/he is severely disadvantaged.  The manager-spouse, on the other hand, often believes that the non-manager spouse views the business as some kind of money tree.  “On the contrary,” s/he thinks, “without me, the business is worth nothing.”  It is critical that a competent and trusted business valuation professional keeps the burner under this volatile emotional stew on Low.

The referring professional, such as an attorney, should ensure that the individual s/he selects has the following qualities.

  1. A reputation for honesty, integrity and impartiality, including in court, where the line between expert and advocate is so easily crossed.
  2. Experience in neutral business and professional firm valuation, especially in the context of family law.
  3. A keen understanding of, and feel for, the human relations aspects of divorce in general, and business value negotiation in particular.
  4. A commitment to the Collaborative divorce process, as evidenced by training, group membership and active participation in fostering the growth of Collaborative Practice in his or her community.

First Meeting

The first meeting can include respective counsel and/or the neutral Financial Specialist, but there is a cost associated with enlarging the meeting, and that is generally not necessary.  For both spouses to embark on a calm and productive valuation process, certain key elements must be established from the outset.

  1. The expert’s credentials (experience, expertise, publications, etc.) impart a sense of confidence in this individual’s technical competence.
  2. The manager-spouse must feel that “reality” will be front and center in this process – especially, that value will constitute what it is worth to the manager-spouse to own the community’s entire interest in the business (rather than his or her community property half) and not what it is worth to some hypothetical outside buyer.
  3. The non-manager spouse must believe that the valuation expert will control the flow of information and analysis.
  4. The expert is, in truth, totally impartial.  Making it clear from the outset that the expert will not be available to perform consulting assignments for the company down the line will go far to cement this critical impression.
  5. The process will be transparent and approachable to all concerned, including both spouses and all advisors.  If, at any time, either spouse wants the expert to look at an issue, talk to an individual and/or review a document, the expert should do so, irrespective of whether such an investigation promises to be productive.
  6. The parties must receive a firm fee quote, rather than a request to sign up for some open-ended hourly commitment.  Divorce is stressful enough without having to worry about how much the next coffee break is going to cost.
  7. Finally, the expert must confirm the impression that s/he has no ego in the game.  The best way to accomplish this is to have the report be “Preliminary” in nature.  If any party to the process can make a convincing case that revisiting any aspect of the valuation process could have a significant impact on the expert’s opinion, s/he should do so without objection or delay and, then, furnish a Final Report in due course.

Conclusion

Collaborative divorce is a splendid out-of-court process that can assist the spouses to communicate more effectively and to negotiate more productively.  If the parties make the necessary commitment to the process, they have a much better chance to maintain human decency, protect their children, and to help the entire family to get on the other side of the divorce decree in one piece.

It is well worth the effort.


This article has been contributed by Steven D. Popell CMC (Certified Management Consultant.) Steve has been qualified as a business valuation expert since 1974, and has published extensively on this topic. CMC, a certification mark awarded by the Institute of Management Consultants USA, represents evidence of the highest standards of consulting and adherence to the ethical canons of the profession. Steve was a 2007 winner Collaborative Practice California Eureka Award for contributions to Collaborative Practice in this state and is a Senior Partner in Popell & Forney, with offices in Los Altos Hills and Pleasant Hill, California.

Business Valuation in divorce is different

by Steve Popell on April 15, 2010

In most business valuations, the standard is “fair market value.”  This method seeks to determine what a hypothetical “willing buyer” would pay a hypothetical “willing seller” in a hypothetical “free market” in which both buyer and seller are in possession of all material facts and neither is forced to make a deal.

In a divorce, however, the buyer and seller are known.  Typically, the manager-spouse “purchases” the community property interest of the non-manager-spouse through the process of community property division.  The standard of value in this case should be “investment value,” because it reflects what it is worth to the manager-spouse to own all of the community’s interest in the company, rather than just his or her community property half.

As with a fair market valuation, an investment value process analyzes a number of elements that are recognized by the appraisal community to be of particular relevance in valuing any privately held company.  Internal Revenue Ruling 59-60 lists the following:

  • Nature and history of the business
  • General economic outlook, and specific prospects for the industry
  • Net worth and financial condition
  • Earning capacity
  • Dividend paying capacity
  • Extent of goodwill, if any
  • Size of the block of stock being valued, especially if it represents a majority or minority interest
  • Whether the stock in question is voting or non-voting
  • Stock prices of comparable public companies, if any
  • Sale(s) of company stock at or near the valuation data
  • Limitations or restrictions on the stock, such as on transfer, dividends, etc.
  • Sale(s) of stock in comparable closely-held companies, if any (implied)

Of these, the two most important are earning capacity and financial condition.

When a company or individual acquires, or invests in, a business of any kind, the main reason is almost always the expectation of a return on that investment.  ROI comes from future earnings.  Sometimes, these earnings are presented as the bottom line on the Profit & Loss statement.  In other cases, the calculation may reflect cash flow.  But, the principle is identical.  Future operating performance determines the return on investment and, therefore, future earning capacity is a key factor in determining value.

Financial condition is also extremely important for a number of reasons.  {Note: a future post will discuss in detail practical financial analysis for a privately held company.}

  1. A strong balance sheet allows management to pursue opportunities for growth, either self-funded or with outside debt.
  2. Banks require the maintenance of specific financial numbers (such as Working Capital and Net Worth) and ratios (such as Current Ratio and Quick Ratio) to maintain an existing line of credit.  In today’s economy, most banks are far more rigid regarding these standards than they were previously.
  3. Regardless of the prospects for earnings growth, most companies experience occasional “bumps in the road” on the P&L.  A strong financial condition will allow the business to weather these times.  The company that has been paying last quarter’s Accounts Payable with the collection of next quarter’s Accounts Receivable has no margin for error.  The loss of a major customer or receivable can put such a company in serious financial jeopardy.

If the business being valued in a divorce is a sole practitioner professional firm, the Excess Earnings Method will often be the most appropriate.  Here, the difference between the practitioner’s earnings (salary + benefits + pre-tax profit) and “reasonable compensation” (what s/he could earn in the same position as a non-owner / non-partner employee of a comparable firm) is called “excess earnings.”  {See previous post on Reasonable Compensation.}

Excess Earnings times a multiple (reflecting the level of confidence that these excess earnings will continue in the future) equals “Goodwill”.  Goodwill plus Net Worth (minus a reasonable return on Net Worth) equals value in the Excess Earnings Method.

In most valuations, in or out of court, the expert will deliver an opinion on a specific value.  In the context of divorce, however, it is far preferable to provide an initial range of value for two important reasons:

  1. It is much easier for the spouses to agree on a range of value than on a specific dollar amount.  Once they have done that, settling on a final number becomes a much more manageable task.
  2. Often, the value of the business can be juxtaposed against, and negotiated against, spousal support.

For example, if the spouse to be supported is mid-30s with a high paying job, s/he may be keenly interested in a substantial buy-out that can be used as an investment or retirement vehicle.  Contrariwise, consider the individual in late 50s with little income history or prospects, who has been living a very comfortable lifestyle (probably supported by the business.)  This person may be far more concerned with maintaining that lifestyle (e.g. keeping the children in the same school district) and would be willing to give a little in the value of the business to achieve this objective.  A range of value assists the couple to carve out this kind of win-win.

Another important contribution that the valuation expert can make to this difficult and highly emotional process is to produce a preliminary report that is open to criticism.  If either spouse can make a persuasive case that the expert has erred in some aspect of the valuation process, and that revisiting the issue(s) could have a significant impact on the expert’s opinion, s/he should be quite open to doing that.  The only objective here is the welfare of the clients, and pride of authorship has no place.

In the final analysis, the expert’s role is to assist the divorcing couple to agree on a value for the business that they understand and believe is fair.  If the expert is able to accomplish this goal, s/he will have made an important contribution to the family and, most importantly, to any children in that family.


This article has been contributed by Steven D. Popell CMC (Certified Management Consultant.) Steve has been qualified as a business valuation expert since 1974, and has published extensively on this topic. CMC, a certification mark awarded by the Institute of Management Consultants USA, represents evidence of the highest standards of consulting and adherence to the ethical canons of the profession. Steve was a 2007 winner Collaborative Practice California Eureka Award for contributions to Collaborative Practice in this state and is a Senior Partner in Popell & Forney, with offices in Los Altos Hills and Pleasant Hill, California.

Selecting a Business Valuation expert

by Steve Popell on February 18, 2010

Introduction

There are myriad reasons why the owner of a privately held company may want or need to have the company valued, including (partial list):

  1. Acquiring another company
  2. Selling the company
  3. Buy-sell agreement
  4. Repurchase of minority shares
  5. Divorce
  6. Partnership breakup
  7. Estate planning
  8. Probate

Regardless of the reason for the valuation or the urgency of the task, finding the right expert will pay off in the quality and utility of the opinion.  Here are a few tips to help you to make the best choice.

Background Check

Just as in hiring, you accept a resume on face value at your peril.  Always check references and publications.  In addition, go beyond the references provided by the expert.  You can do this simply by asking the listed references for the names of others who may have valid input on the competence and relationship skills of this individual.  These are called secondary references, and will typically be a more reliable source of information than the primary references.  You can even take it a step further by asking the secondary references the same question and, thereby, developing tertiary references.  Some questions you may want to ask will include the following.

  • Did the expert communicate clearly on all aspects of the prospective assignment at the initial meeting?
  • Did the engagement letter accurately reflect the shared understanding of the purpose of the assignment?
  • Was there a firm fee quote, or did the expert work by the hour?
  • Did the expert exhibit a genuine commitment to impartiality?  In other words, did the expert indicate clearly that s/he would simply go where the evidence led?
  • Was the request for data, including financial, reasonable?  If you didn’t have a particular document or piece of information readily available, did the expert insist on getting it, even if it seemed tangential?
  • Did the actual performance of the expert (data gathering, analysis, report, etc.) match up well with what you expected, based on the initial meeting and the engagement letter?
  • Was the report clear and easily understandable – even by non-financial people?
  • In the case of a divorce valuation, was the expert sensitive to the emotional aspects of the process?
  • How did the expert relate to other professionals on the case, such as a Collaborative Practice team, attorneys or mediator?
  • If you had to make this choice again, would you select this expert?

Absence of Ego in the Process

There is no place for ego or pride of authorship in the business valuation process.  One way to scope out this aspect of an expert’s approach is to determine if s/he is willing to submit a preliminary report that is open to criticism.  It is always possible that even the most competent expert will over-emphasize or under-emphasize some important data or, perhaps, miss something altogether.  It is also possible that something unexpected has cropped up during the valuation process that was knowable as of the valuation date, but the client(s) neglected to mention same.  The expert should be open to (even anxious for) the client(s) to provide such feedback.  The objective, after all, is the best valuation report possible, not the easiest to crank out.

Fundamental Understanding of What is Really Going On

Fair Market Value (FMV) is defined as what a hypothetical willing buyer will pay a hypothetical willing seller in a hypothetical free market in which both sides have essentially all the information they need to make an informed decision, and neither is compelled to conclude a transaction.  FMV is an appropriate standard of value in many situations, such as probate or any other circumstance in which the opinion will be presented in court or involve the IRS or other federal or state agency.  However, a number of other scenarios call for a different standard of value.

In a divorce, for example, or for a buy-sell agreement for a company with 2-4 owners, investment value is far more appropriate than fair market value.  The reason is very straightforward.  In either of these situations, the objective is not to determine what some outsider would pay for the company, or a portion thereof.  Rather, it is to ascertain what it is worth to one spouse (or one owner) to own a greater share of the company.

Avoid an expert who fails to grasp this critical distinction.

Flexible Fee Schedule

Anyone can charge several hundred dollars per hour.  It is more challenging to provide a fee schedule that offers the client genuine choices.  There are a few key questions in this regard.

  1. Will this opinion be offered in court or to some government agency?  If so, an “official” opinion will be required, and will be the most expensive.  If not, does the expert offer an “unofficial” opinion for a lot less money?
  2. Can delivering a much shorter report cut the cost significantly?
  3. Is there a choice between a broadly based analysis and report and one that considers financial documents only?  Is door #2 cheaper.

In sum, you have a right to expect quality performance from an expert with whom you have an excellent relationship, and for a cost that is commensurate with you needs.  Go for it!

This article has been contributed by Steven D. Popell CMC (Certified Management Consultant.) Steve has been qualified as a business valuation expert since 1974, and has published extensively on this topic. CMC, a certification mark awarded by the Institute of Management Consultants USA, represents evidence of the highest standards of consulting and adherence to the ethical canons of the profession. Steve was a 2007 winner Collaborative Practice California Eureka Award for contributions to Collaborative Practice in this state and is a Senior Partner in Popell & Forney, with offices in Los Altos Hills and Pleasant Hill, California.

strageic acquisition just askThe Excess Earnings Method is the most commonly used approach to valuing a sole practitioner practice in family court.  In this method, “Excess Earnings” equal practice earnings in excess of the sum of reasonable compensation and a reasonable return on the practice’s Net Assets.  Excess Earnings times a multiplier (reflecting the relative risk of the earnings stream) equals Goodwill.  Goodwill plus Net Assets equals the total value of the practice.

Since Goodwill typically represents the majority of value, the excess of practice earnings over reasonable compensation (what the practitioner could earn if employed elsewhere in the same specialty) is the key element in this process.  Unfortunately, an often substantial portion of practice earnings is counted twice in a court settlement: first, in the valuation of the practice and, second, in determining support payments.  This problem of “double dipping” raises serious questions about the fundamental fairness of the method.

How It Works

Let’s say that a female CPA (the primary breadwinner in the household) earns $200,000 per year after all expenses in her solo practice.  Her firm’s Net Assets equal $50,000, and a reasonable return on those assets would be 10%.  If she were to do the same work for a comparable practice, she would earn $120,000.  Therefore, practice earnings exceed reasonable compensation by $80,000 per year.  Since her practice earnings stream appears to be relatively secure, the multiplier is set at 4.  The calculation of practice value would be as follows:

Excess Earnings          $80,000 ($200,000 minus $120,000)

Minus              5,000 (10% of $50,000)

Equals          $75,000

Goodwill         $  75,000 (Excess Earnings)

Times            4 (Multiple)

Equals         $300,000

Practice Value          $300,000 (Goodwill)

Plus                        50,000 (Practice Net Assets)

Equals                      $350,000

So far, so good.  But, now, the question becomes how much of her earnings are used to calculate spousal support?  If the entire $200,000 is part of the calculation, $80,000 of that total is being counted twice: first, in determining Goodwill and, second, in setting support payments.

Put another way, she has already “purchased” her community property half of the $80,000 annual earnings stream from her spouse for $150,000 (the value of his 50% community property interest in Goodwill) and will pay for it again as part of spousal support.  Small wonder that many sole practitioners believe that they are getting a raw deal.

Solution

Since the culprit in this situation is the double counting of Excess Earnings, the solution lies in ensuring that Excess Earnings are counted fully only once – either in practice value or in spousal support, but not both.  Importantly, there is no compelling philosophical argument for mandating either choice in all cases.  In fact, practice value and spousal support are often negotiated as trade-offs in community property settlements.

For example, if short-term income is the supported spouse’s principal need, then additional spousal support may be far more important than higher practice value.  This couple may agree on maximum spousal support and a somewhat smaller value for the practice.  On the other hand, if the spouse has a high-paying job, the opposite may be true.  This second couple may agree to a maximum value for the practice (that the spouse can use as an investment or retirement vehicle) along with somewhat reduced spousal support.

The critical element in all this is that each party identifies and articulates his or her principal priorities.  By so doing, they are “enlarging the pie.”  In other words, rather than playing a zero sum game (my win in your loss and vice versa) they collaborate to help one another to achieve their most important objectives.

Conclusion

Double dipping is inherently unfair, because it requires the sole practitioner to pay twice for the same income stream (the amount by which practice earnings exceed what s/he could earn as an employee of a comparable practice.)  An approach that allows the parties to choose the most reasonable and appropriate combination of practice value and support payments will best serve the long-term interests of all concerned.

The couple’s ability to reach agreement on the value of the business (a typically nettlesome issue) will often “lower the temperature” in the room, thereby facilitating agreement on other issues – including non-financial ones, such as custody and visitation.  It’s not often that one gets the chance to take two bites out of such an important apple.  Go for it!

PhotoPopellThis article has been contributed by Steven D. Popell CMC (Certified Management Consultant.) Steve has been qualified as a business valuation expert since 1974, and has published extensively on this topic. CMC, a certification mark awarded by the Institute of Management Consultants USA, represents evidence of the highest standards of consulting and adherence to the ethical canons of the profession. Steve was a 2007 winner Collaborative Practice California Eureka Award for contributions to Collaborative Practice in this state

Collaborative-PracticeThe frequently destructive effects of litigated divorce, especially on minor children, are well known. While the lawyers get much of the blame, the fault really lies with a legal system that, all too often, turns adversaries into enemies and spouses with common interests into winners and losers.

It doesn’t have to be this way.

There is an alternative that can provide all the legal protections of a court process, minus most of the downside. It is called Collaborative Practice (CP), and it deserves your close scrutiny. CP is different from litigation in three important ways.

1. The spouses agree in writing not to go to court. If either party abrogates this agreement, all professionals must withdraw.

2. The spouses agree in writing to provide all relevant information, whether requested or not.

3. While the final settlement must be filed with the court, the couple, not a judge, makes all decisions.

There is a core team of professionals, including an attorney for each spouse, a coach for each spouse, a neutral financial professional and, if there are minor children, a child specialist. When there is a family business, the couple retains a neutral business valuation specialist.

With a neutral, two draining elements are greatly reduced – cost and stress.

The Cost is cut down as the hourly rates for financial and mental health professionals are typically much lower than those of family lawyers, the cost for CP is often less than with litigation. In addition to that, neutral business valuation is much less expensive, because there is only one expert, rather than two; and finally, there is no need for depositions and court appearances and, therefore, legal fees are also cut substantially.

The Stress from a protracted battle over the value of the business can take a heavy emotional toll. The non-manager spouse can feel over matched and at sea in a situation so laden with numbers and financial concepts. The manager spouse is often genuinely afraid that buying his or her spouse’s community property interest in the business will kill the goose that is supposed to be laying the golden eggs. Rival experts can exacerbate these fears and misgivings.

Not surprisingly, the business valuation professional in the Collaborative environment is quite different from the one that delivers an opinion in court. Here are a few of the key differences.

1. The function of this professional is to help the divorcing couple to agree on a value for the business that they understand and believe is fair.

2. The professional is free to deliver a preliminary report, which is open to criticism. If either spouse can make a persuasive case that revisiting an issue, reviewing a document or interviewing a person may have a material impact on the opinion, the expert should be happy to do so. This can never happen in court, where defending one’s opinion is the order of the day.

3. The expert is also able provide a range of value, rather than a specific dollar amount. This option is advantageous for two reasons.

• It is easier for the couple to agree on a range than on a number. Once this threshold is crossed, agreeing on a point within the range should be well within their grasp.

• A range of value allows the spouses to juxtapose business value and spousal support in ways that are beneficial to both parties. For example, a young spouse with a high paying job will often want to maximize the value of the business for use in an investment or retirement vehicle. S/he would probably be willing to sacrifice something in spousal support to achieve this goal. An older spouse with limited income prospects may be primarily interested in maintaining the lifestyle that the business has supported. This individual can afford to give a little in the value of the business in order to maximize spousal support.

When retaining a neutral business valuation specialist, the couple must make two key decisions: the valuation date, and the level of service. In court, the valuation date is typically selected because it is close to the date of separation (business highly dependent on the efforts of the spouse) or to the date of trial (many others, besides the spouse, contribute to the financial performance of the company.) In Collaborative Practice, neither of these markers need be dispositive. Rather, the decision revolves around practical issues, such as proximity to the end of the calendar or fiscal year, at which time the quality of financial information is usually much better than at other times during the accounting year.

In Collaborative Practice, the expert can offer a number of choices in service that accomplish different objectives and cover a wide range of cost. For example, if a valuation opinion were for court, the IRS or some other official body, an official opinion may be required. That is almost never the case in Collaborative Practice, and an unofficial report is much less expensive. In some instances, it is necessary only to review financial documents, rather than cover the entire business landscape – another way to save money. It is not necessary to satisfy a judge in this matter. Rather, the question is: What makes sense for the couple and their available resources?

My future posts will add detail regarding business valuation in the context of Collaborative Practice. In the meantime, if you or someone you care about is entering a divorce process, Collaborative Practice should be front of mind. You can learn more about this important option by visiting the Collaborative Practice website. The site will also help you to find Collaborative professionals all over the U.S. and around the globe


PhotoPopellThis article has been contributed by Steven D. Popell CMC (Certified Management Consultant.) Steve has been qualified as a business valuation expert since 1974, and has published extensively on this topic. CMC, a certification mark awarded by the Institute of Management Consultants USA, represents evidence of the highest standards of consulting and adherence to the ethical canons of the profession. Steve was a 2007 winner Collaborative Practice California Eureka Award for contributions to Collaborative Practice in this state.