If a couple divorce, all the assets that both spouses have an interest in are considered relevant assets. This includes any interests that either spouse has in a business, including shares in a private limited company or a partnership interest. A value will need to be ascribed to these business interests in a divorce.
Businesses come in all shapes and sizes. Some are small businesses that have very limited assets and are just an individual working on a self-employed basis, for example an IT consultant who works through a limited company. It is unlikely that this type of business will have a value, as the business is just a vehicle through which that person earns an income. If you take that person away the business has no value, save for any money held in its bank accounts.
Other types of businesses are likely to have a value and will need to be valued within the divorce, unless a value can be agreed by the couple. If a business valuation is needed, it is usual for the couple to jointly instruct an accountant, who is an expert in business valuations, to prepare a valuation report. Valuing a business is an art, not a science, so different accountants will attribute different values to the same business. Some accountants are more conservative than others with their valuations. It is therefore important that you take advice upon the right accountant to instruct before going down the valuation route.
Most businesses are valued in one of two ways – a net asset basis or an earnings basis.
Net Asset Basis
Businesses that have significant assets, such as properties, are often valued on a net asset basis. This is the value of all the assets owned by the business less all of the debts. Where the business owns assets such as properties, it may be necessary to obtain up to date valuations of these before the accountant prepares their report.
Earnings Basis
This method is usually appropriate where a business is trading and generating a profit from that trade. Typically, this method requires the assessment of the likely level of Future Maintainable Earnings and the application of an appropriate multiplier. To do this recent trading performance is considered. Often for the last three full trading years.
Usually the jointly instructed accountant will undertake both calculations and use the highest figure. Therefore, a trading company could be valued on a net assets basis if its assets have a very high value or alternatively if the recent trading performance has been poor and therefore the Future Maintainable Earnings are low.
Once the accountant has valued the business, they must also consider the tax that would be payable by the business owner if their interest in the business were sold. This is because the divorce court uses the net value of the spouse’s business interests, when considering what a fair financial settlement is.
If the spouse does not own the whole business, the accountant will consider whether the spouse’s interest should be valued on a pro-rata basis or whether a further discount should be applied. Often a discount is applied if the spouse has a minority interest in the business.
The accountant will also need to consider liquidity. This is the amount of money that can be taken out of the business by the spouse, without impacting its ability to function as a business. The tax consequences of taking this money out of the business must also be considered. If a business has limited or no liquidity, this is a factor that will have to be taken into account when considering what a fair divorce settlement is.
If it is considered appropriate for the business owning spouse to pay money to their spouse as part of the divorce settlement, the payment of this money may take place over a few years if insufficient money can be raised through the business or from elsewhere to pay it upfront in one payment.
A judge does have the power to order the transfer of shares from one spouse to another within divorce proceedings. However, it would be fairly unusual for this to happen if only one spouse has ever worked in the business. A judge can also order a sale of shares in a business, but this would be very rare and could not happen if there was a third party with an interest in the business.
