Sharing the Spoils
Article, Law Society Gazette – April 2007
Legal / Disputes
Catherine Rawlin and Naim Qureshi look at the role of forensic accountants in valuing businesses for high-profile separations.
High-profile divorces such as that of celebrity chef Rick Stein and his wife, along with the ongoing saga between Heather Mills and Sir Paul McCartney have recently made headlines. In the case of rich celebrities, part of the fascination lies in finding out how much of the celebrity’s fortune the lesser-known partner is entitled to. We also suddenly hear just how much household names are worth.
But how are these numbers calculated? And how much science is used in arriving at them? A lot of the value will relate to assets and often these may include a business (or more than one).
Since White v White  1 AC 596, correct and up-to-date valuations, particularly of businesses, has assumed greater importance. Therefore, the power in part 35 of the Civil Procedure Rules (CPR) to appoint joint experts should be invoked where necessary. However, careful consideration should first be given to whether valuation evidence is both relevant and cost effective. For example, a detailed valuation may be unnecessary where it is agreed that the business should remain intact and the issue is liquidity and/or borrowing ability.
In some situations, the other party to the divorce may be suspicious that the profits of the business are being deliberately dampened to assist in minimising the divorce settlement. This can especially be the case where the standard of living of the business owner could not have been supported by the disclosed performance of the business, and/or where the results of the business have unexpectedly changed following the separation.
Where this is a possibility, the forensic accountant will examine the books and records of the business to ascertain why income has reduced and/or why costs have increased to cause the disappointing performance. It may well be that the business performance has gone downhill for valid reasons, such as competitors entering the market, loss of a key customer, or an increase in the purchase price of raw materials. However, if there is no valid reason for the changes, the forensic accountant should be able to demonstrate this.
Once there is comfort that the accounting records of the business show a true picture of its financial performance, the forensic accountant can proceed with the valuation of the business. It should be recognised that this type of valuation is an art and not a science. It is likely that two different professionals given the same set of facts will each come out with a different answer (although in theory, they should be the same). The UK also lags behind Canada and the US in that there is no qualification that can be gained in this country for the valuation of businesses.
Shares in private companies are worth what someone will pay for them. Therefore, they may have a nil value. In valuing private shares, discounts may need to be applied where the interest is not a controlling interest. Even where the goose should not be sold, it may still stand as security for borrowings.
In the case of private limited companies, it is essential that there be discovery of the company accounts over a period of three years or more, if it is thought necessary. The trends and financial status of the company can be ascertained. Sometimes it will be necessary to seek further information to value the shares properly, especially where some or all of the assets consist of real property in the ownership of the company. Sometimes information will be sought by way of a questionnaire under rule 2.63 of the Family Proceedings Rules 1991, a subpoena against the chairman or secretary of the company, or a production appointment under rule 2.62(7)-(9).
Accountants can assist with formulating proposals and investigating and organising disclosure, including a forensic analysis of the company accounts.
There are several ways to perform a business valuation, depending on the type of business involved. The two main approaches are asset-based and earnings-based valuations. The former method is less common and tends to apply where the value of the assets lies in the price for which they could be sold - for example, in a property development company, rather than in their future use to generate profits.
An earnings-based approach can take a number of different forms. The most common is to calculate a level of annual ‘maintainable earnings’ for the business and apply a multiple to this. The idea is that a purchaser of a business is, in effect, buying a future profit flow from the business.
In arriving at maintainable earnings, adjustments may have to be made, for example, for non-recurring expenses, or to replace the owner’s salary with one that will reflect the market rate for the job that the owner does in the business.
Often, where a business is owner-managed, the valuation may have to take account of the important role that the person has in the business. This means that, for example, if the person were taken out of the business, would it have a major impact? This type of issue will usually be dealt with either by reducing the multiple used or deducting the profits that would be demanded by the key person from maintainable earnings.
Another factor to consider is that in many cases a wife is employed by a husband’s company to enhance the family’s income by utilising personal tax allowances and taxation levels of two individuals. If the employment of the wife ceases, although the income of the husband may increase, the overall tax burden will be larger as there will be no transfer of personal allowance, and it is likely that this income will be liable to higher-rate tax.
A further factor to consider is that the wife’s salary from the family company may or may not reflect her actual earning capacity.
Frequently in a divorce situation, there is no intention that the business would be sold. Indeed, the livelihoods of both parties may depend on it continuing. Where this is the case, it is important to consider how the value of any settlement will be raised from the business.
The practitioner must give careful consideration throughout any valuation process to the amount of costs being incurred in trying to value a share in a partnership or company. If the business is the asset from which the income to fund periodical payments to the wife is to be produced, care should be taken not to destroy that asset or significantly reduce its value by expensive valuations. The courts have also warned solicitors and their clients against incurring disproportionate costs in valuing a party’s shareholding in a company (see P v P (Financial Provision)  2 FLR 241 and Potter v Potter  4 FLR 331).
With the growth in divorce rate and the number of people owning and running their own business, the measure of the true cost of marriage breakdown will continue to be a difficult area for couples and their advisers.
As appeared in Law Society Gazette, April 2007.