Buried Treasure: Business Valuation in Divorce
When a company’s owners are going through a divorce, performing a business valuation and finding true business value take on a new complexion
The typical financial crime is sparked more by the
desire for financial gain than by the desire to hurt the victim. That may not be
true in a divorce, though, where one party may wish to cheat the other out of
his or her fair share of marital property for the sole purpose of inflicting
humiliation, emotional distress or financial injury.
Divorce is an emotional event, and because the
anxiety, anger and mistrust can be so profound, it is common for one spouse to
insist that the other is hiding or undervaluing significant assets.
Suspicion can reach unprecedented heights when the
couple’s estate includes a closely held company. In such cases, the presumption
by the uninvolved spouse that the owner-spouse is suppressing the company’s
value is almost a given. Determining whether that presumption holds water often
requires that a business valuation professional investigate the business’s financial
records. Once analyzed, the valuator can understand the location of assets,
track any significant changes in spending habits of either spouse prior to the
date of separation, and look for patterns or breaks in patterns that may point
to suspicious activity.
Know the Company
A key reason for understanding the location of
assets is to help identify whether any have been removed from the business. The
first step in making this determination is to thoroughly understand the company.
That makes it easier to identify changes in business patterns that might
indicate whether assets have been shifted out of the company. Some of the
questions a valuator may ask about the company include:
What types of products or services does it
How do trends in other industries affect its
Have there been changes from year to year in
key areas of its balance sheet or income statement and the corresponding
Has the company or its shareholders recently
submitted financial statements to lenders?
Who are the company’s customers?
Has the level of business from these customers
Have key customers been leaving the company for
a single competitor or a new company?
The answers to these questions may reveal some
previously unknown facts. For example, a review of sales activity logs may show
a sudden decrease in revenues from a major customer. Further investigation may
show that several customers have switched their business to the same new
competitor. It may turn out that one spouse is a partner in the competing
business, which was set up for the express purpose of siphoning off key accounts
from the existing business to reduce its value in the divorce settlement.
Know the Industry
Just as an understanding of the company in question
can help a valuator unearth unusual patterns or trends in its business, so can a
thorough knowledge of the industry in which the company competes. Trends within
the industry as a whole, as well as with the business’s competitors in
particular, affect the business and provide additional insight to the valuator.
Questions a valuator may ask include:
Is the industry in a growth phase?
What are common earnings for other members of
What are common levels of expenses?
What other relevant industry trends affect the
Is the competition experiencing similar trends?
If a valuator suspects that a business owner is
siphoning off assets from the company by manipulating the accounting records,
the valuator should look at statistics from similar companies. As a rule, two
companies with similar levels of business should have similar levels of
expenditures. If one company is spending twice as much as a comparable
competitor on supplies, financial manipulation may be the cause. A detailed
analysis of the subject company relative to its peers may highlight areas that
require additional investigation or point the valuator in the right direction.
Make Sense of Emerging Trends
Unearthing hidden assets can be a painstaking
process, because the owner-spouse may have started taking steps—perhaps months
or years earlier—to cover his or her tracks in anticipation of an increased
level of scrutiny.
Careful investigation of the company and the
industry (as well as consideration of other factors, such as the individuals
involved) can often reveal the trends that will show a valuator how and where
assets have been moved.
Finally, a personal lifestyle investigation can be
a useful tool to highlight unreported income and can be thought of as a “sanity
check” to financial representations made by a dishonest spouse. For example, is
the spouse’s reported income truly sufficient to support his or her apparently
high standard of living? Any shortfall between reported income and lifestyle
expenditures should sound a warning and may warrant additional investigation.