When one or more of the owners of a business think it is time to get divorced, the decision in invariably accompanied by hard feelings. As most clients ultimately learn, the courts are incapable of resolving emotional issues. But they deal pretty well with money – which is why it makes sense to find out how much is at stake in the fight that is likely to ensue. Save the emotions for therapy; money is what the case is about.
The Pitfalls of Misinformation
My experience is that most clients are pretty thoroughly misinformed about the “fair value” of their business as well as their individual interests. Not infrequently, clients will presume that the high price-to-earnings ratio that one may find in the market of publicly traded stocks will apply equally to their closely held business. Not so. Others will fail to recognize the effect that the unusually high salaries paid to the owners will likely have in inflating the value of the business.
Lawyers, meanwhile, have a tendency to assume that their client knows the real value of the business and may make judgments and assessments without enough information. And as we discussed in a recent post, the most confident of us at the bar are also the most likely to overestimate the return that we can secure for our client. Thus, objective, even if incomplete, information about the value of a business is critical to effective decision making.
There are any number of variables that are unique to the process of formally valuing a business. These are ordinarily well beyond the expertise of the accountant who prepares the tax returns or audits the books, so it makes sense to bring in a consultant early to do an informal valuation. Doing so lets lawyer and client make informed judgments about the resources that should be devoted to this dispute.
Making an Educated Investment
Once we know the value of company, we can make some intelligent decisions about how to proceed to maximize the return. We take a hard look at the costs of the litigation, direct and indirect: attorney’s fees, expert’s fees, disbursements, lost productivity or income. With this information, a client can make informed choices about the litigation strategy.
For example, when the costs of litigation are factored in, the offer made by one of the parties may be more attractive. Long-term litigation may be detrimental to the income of the principals. In some cases, the party that will ultimately pay the purchase price will have to make some hard decisions about funding the settlement.
Sometimes both sides want to keep the business. At other times, one person simply wants to be cashed out. The parties may want – or need to – consider the sale of the business as a going concern or dissolution and distribution to the assets. Even the “go-no go” decision of whether to file a lawsuit can be implicated. If there is not much good will in the business and the operating agreement does not prohibit withdrawal, it might make more economic for a client to quit and start a new business that competes with the old.
Getting the ‘Back of the Envelope’ Appraisal
I typically recommend that clients engage a certified business appraiser very early in the case. (You want to get someone who has the credentials to testify later if necessary.) Appraisal has its own fact-finding procedures and standards, so you cannot expect anything approaching a final valuation report.
Nonetheless, the consultant who should be able to evaluate the assets and cash flow of the business. The consultant typically will research the discount rate (rate of return required by a prospective purchaser) and come up with a value based on the businesses’ cash flow. A relatively detailed description of the business provided by my client, recent tax returns and copies of income statements and balance sheets are usually sufficient for this purpose.
The question of what goes into a valuation is beyond the scope of this post. I wrote something recently (post here). Peter Mahler’s blog www.nybusinessdivorce.com also has some very informative posts concerning New York corporations. Although New Jersey law is a bit different in certain respects, most of the information is of universal application.