Part 1: Methods for Valuing a Business
When a couple separates, it is important that both people are able to move forward with financial independence. This is sometimes complicated by the fact that a family business might be involved, where both parties have worked during the relationship. Even when this is not the case, the value that is placed on that business can often be a source of conflict. In practice, when the parties do not agree about the value of a business that one or both may have an interest in, it is necessary to have the business valued. This is necessary even where there is no intention by either party to have the business sold.
The case of Wilde & Wilde (2007) states that there are five ways a business can be valued in family law matters:
- Discounted cash flow
- Capitalisation of future maintainable earnings
- Value of net tangible assets (going concern basis)
- Notional realisation of assets
- Capitalisation of future maintainable dividends
‘Discounted cash flow’ or ‘DCF’ refers to the present value of the future streams of income which a business is expected to bring in, discounted to account for interest rates and risks associated with the business. DCF is considered the most accurate methodology for valuing business; however, it also requires the valuer to project how much the business will be worth in 10 years’ time. Many businesses (particularly family owned businesses) do not have sufficient information in terms of long term budgets for DCF to be accurate.
Capitalisation of Future Maintainable Earnings
This method is most often used to value profitable businesses. It values a business on the basis of how much a business is earning now and how much it will be earning in the future, and accounts for any growth that the business might undergo. Goodwill is taken into account. This method can be problematic for businesses with high growth or abnormal capital expenditure.
Value of Net Tangible Assets
This method is used where a business is profitable and will likely continue to be so, but there is no goodwill because the profits of the business are not high enough. Essentially, the methodology is used where the amount of revenue that a business receives from its intangible assets (for example, patents, goodwill, trademarks) does not exceed the net tangible business assets (for example, machinery, cash, plant) which generate profits.
Notional Realisation of Assets
This method is used where a business will probably not continue into the future. The business is valued based upon how the assets of the business would be sold; for example, through a fire sale or through liquidation. This method is also used to value a person’s interest in a publically traded company, such as shares.
Capitalisation of Future Maintainable Dividends
This method is used only where a person has a minority interest in a business, and attempts to work out what the value of that interest is on the basis of dividends which a person has received in the past.