Pandemic Creates Unique Business Valuation Challenges
The COVID-19 pandemic has had a devastating impact on the economy and created significant uncertainty. For couples involved in divorce proceedings, the current environment presents unique challenges as the parties strive to reach an equitable property division agreement.
Matter of Fairness
In both equitable distribution and community property states, fairness is a primary concern. Rarely is ownership of a business, real estate, retirement accounts or another marital asset simply split 50-50 between the spouses. Rather, courts are more likely to award a business to the spouse who is active in operating it and a home to the spouse who continues to reside there. To achieve fairness, the parties will work out an agreement to compensate the other spouse by 1) paying him or her a percentage of the asset’s value, or 2) awarding him or her another marital asset of comparable value.
Achieving a fair property division can be challenging in volatile economic times. For example, Mr. and Mrs. Smith reached a property division agreement on January 1, 2020. Under the agreement, Mrs. Smith would keep the family home, and Mr. Smith would retain his closely held tool-and-die shop. Both assets were valued at $1 million as of January 1.
After multiple COVID-19-related postponements, the couple’s property division hearing was heard in the Fall. As of the new trial date, however, the value of the business was only $700,000, while the home’s value is still $1 million. Is the original agreement still fair? Should the parties return to the negotiating table?
Known vs. Knowable
Often, the valuation date is set by the court. But what happens if divorce proceedings were initiated in late 2019 or early 2020, and the value of a business has declined dramatically as a result of the pandemic? A business’s value is generally based on facts that were “known or reasonably knowable” on the valuation date. Subsequent events that affect value – but fail to meet this standard – are usually disregarded. However, professional standards generally require valuators to disclose subsequent events in their reports and explain how those events affect value.
For valuation dates that are later in the year, the pandemic’s impact may be clearer. But uncertainty over the future still creates business valuation challenges. Will the business recover? If so, how long will it take? Will it bounce back quickly once the pandemic ends, or has it suffered more lasting damage? Businesses have been affected by COVID-19 differently – and some have even flourished during the pandemic.
During this volatile time, valuation experts are likely to emphasize income-based valuation techniques, such as the discounted cash flow and capitalization of earnings methods. These techniques can be adjusted to reflect current business disruptions while capturing a projected return to a “normal” level of profitability. Predicting if, and when, that will happen is no easy task, however.
Flexibility is Key
Today, divorcing couples need to keep their options open. They might consider waiting to see how the recovery goes before finalizing their divorce settlements – or at least reserve the right to adjust those settlements to reflect future developments. And, for existing agreements, your clients might consider asking the court to change the valuation date or otherwise modify their agreements in the interest of fairness.
TheKFORDgroup litigation team holds extensive knowledge and experience in expert witness engagements, forensic accounting, and business valuations. Our team is trained and experienced within business valuations and know how to reflect the current business disruptions while capturing a projected return to a “normal” level of profitability. For more information, please call us at 210-340-8351.
Additional information included in this report was provided by PDI Global/Thomson Reuters © 2020