When divorce proceedings involve a privately owned business, share valuations often become one of the most complex and contentious aspects of the financial settlement.
Owner-managed companies introduce valuation challenges that do not arise in larger, professionally managed businesses. In the Family Court context, those challenges are further complicated by issues of fairness, disclosure, control, and personal involvement.
This article explains how owner-managed trading companies are typically valued in divorce proceedings, where disputes commonly arise, and what best practice looks like when expert evidence is required.
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Why Are Share Valuations in the Family Court So Challenging?
Share valuations are forward-looking by nature, yet Family Court cases are often constrained by limited information, time pressure, and cost sensitivity.
The key difficulty is that value does not sit in past profits. It sits in future cash flows, which must be estimated, assessed for risk, and translated into a present value.
In owner-managed companies, reliable forecasts are frequently unavailable, incomplete, or heavily influenced by the individuals who control the business. This makes theoretically robust valuation methods difficult to apply in practice.
Where Does Business Value Really Come From?
The value of a shareholding depends on whether the present value of expected future cash inflows exceeds the present value of future cash outflows.
Three factors determine this:
- The amount of cash expected to be generated
- The timing of those cash flows
- The risk associated with receiving them
Earlier, more certain cash flows are more valuable than later, uncertain ones. Inflation and business risk both erode value over time.This principle applies regardless of the valuation method ultimately used.
Why Is the Discounted Cash Flow Method Often Not Used?
In theory, the discounted cash flow method is the most conceptually sound approach to valuation. It involves forecasting future cash flows and discounting them back to the valuation date using a rate that reflects risk and the time value of money.
In practice, many owner-managed companies cannot produce forecasts of sufficient quality to support this method. In addition, particularly in cases that are not considered high value, the cost of a full DCF exercise is often disproportionate.As a result, alternative approaches are frequently adopted.
Why Are Earnings Multiples Commonly Used Instead?
A common alternative is to apply a valuation multiple to an accounting measure of earnings, most often EBITDA.
This approach uses:
- Earnings as a proxy for future net cash flows
- The multiple as a proxy for risk and return expectations
While this method has limitations, it is often the most practical and proportionate solution in Family Court valuations of owner-managed trading companies.
Other methods may be more appropriate in certain circumstances, such as the net assets method for property investment companies.
How Are Future Earnings Assessed?
Although historical performance must be reviewed, past results do not create value. They merely inform expectations about the future.
Historical earnings typically require adjustment for:
- Exceptional or non-recurring items
- Non-arm’s length transactions
- Costs or income that will not continue following divorce or restructuring
Particular scrutiny is applied to proprietors’ remuneration, including salaries, pension contributions, and expenses. A hypothetical purchaser would assess the arm’s length cost of employing individuals to perform the same roles. Any excess or shortfall must be adjusted accordingly.
Future earnings estimates must also reflect changes expected to arise after the valuation date, such as the loss of a key customer or the award of a major contract.
How Should Adjusted Historical Results Be Used?
Not all historical figures carry equal weight.
Key considerations include:
- Whether figures are audited or unaudited
- The impact of inflation over the period reviewed
- Whether there is a clear upward or downward trend
Where performance shows a consistent trend, the most recent results may best reflect future expectations. A less definite trend might suggest a weighted average. Where results fluctuate without a clear pattern, a simple average may be more appropriate.
Professional judgement plays a significant role at this stage.
How Is the Valuation Multiple Determined?
Multiples are typically informed by:
- Transactions involving comparable private companies
- Data from listed companies operating in similar sectors
Public information on private company transactions is limited, and listed companies are often significantly different in scale and risk profile. Broader valuation indices may offer general guidance, but their usefulness is constrained by the lack of transparency in the underlying data.
In Family Court cases, budgets often limit the scope for extensive market research, reinforcing the need for proportionate and well-reasoned assumptions.
What Makes Family Court Valuations Different?
The Family Court is concerned with achieving a fair outcome in all the circumstances, which may differ from strict market reality.
Common complications include:
- Businesses that might be considered unsaleable, e.g. due to reliance on one spouse’s personal goodwill
- The tension between theoretical market value and practical extractable value
- The treatment of minority shareholdings and control
While minority interests usually attract a market discount, the Court may decide that applying such a discount is inappropriate for settlement purposes. A helpful valuation should therefore present the full market analysis transparently, allowing the Court to make an informed decision.
Why Does the Valuation Date Matter?
Valuations may be required at different points in time.
Issues can arise where:
- The business existed before the marriage
- Significant value was created after separation
- One party argues for hindsight while the other does not
The choice of valuation date can materially affect the outcome and should be carefully considered by the Court before the expert is instructed.
Best Practice for Share Valuations in Divorce Proceedings
Two factors consistently improve the quality and efficiency of valuation evidence:
- Early instruction of an appropriately qualified forensic expert
- Prompt and complete financial disclosure
Delays and incomplete disclosure increase costs, prolong proceedings, and reduce the reliability of the valuation presented to the Court.
Frequently Asked Questions
Why is EBITDA commonly used in Family Court valuations?
EBITDA provides a simplified proxy for operating cash flow and enables comparison across businesses. It is not a measure of value on its own but is often the most practical starting point when other methods, such as DCF, are not possible due to a lack of information or budget constraints.
Can a profitable business have little or no value?
Yes. Accounting profits do not guarantee sustainable cash flow. A business may appear profitable yet lack the ability to generate future cash for shareholders.
Is personal goodwill included in the valuation?
Personal goodwill may have limited or no transferable value if the business depends heavily on one spouse’s skills, reputation, or relationships. This distinction is often critical in divorce cases. However, few people are truly indispensable or irreplaceable, so the issue requires careful consideration.
Are minority discounts always applied?
The market value of a non-controlling interest will almost always stand at a discount to its pro rata share of the market value of the whole. However, the Family Court may choose not to apply a discount when determining a fair settlement. Clear presentation of both positions is essential.
Why do valuation experts sometimes disagree?
Differences arise from areas that require professional judgement, e.g. assumptions about future performance, choice of multiples, and treatment of adjustments. Transparency and clear reasoning are key to enabling the parties and the Court to understand the valuation issues.
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Disclaimer
The information contained in this article reflects the observations and experience of the author in the field of forensic accounting and is provided for general informational purposes only. Nothing in this article should be construed as legal advice, nor should it be relied upon as a substitute for professional legal advice, which (if required) readers should seek by consulting a suitably qualified and experienced legal adviser regarding their specific circumstances. Neither the author nor Frenkels Forensics makes any representations or warranties regarding the accuracy or completeness of any discussions of legal concepts. Neither the author nor Frenkels Forensics accepts any liability for any actions taken or not taken based on the content of this article.
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