Businesses are often valued in the context of a divorce so that the court has a figure to factor into the pot which is shared between spouses. A recent case in the High Court has put in the spotlight a new basis for reducing business valuations in divorce proceedings.
Business valuations in divorce proceedings
Arguments have long been made about how the risk-laden nature of businesses (compared to “copper-bottomed” assets like houses) might be a reason to justify a greater share of the overall asset pot being awarded to the spouse retaining the business. That argument has not always worked, the court often being persuaded that the risk element has already been factored into the valuation by the appointed expert accountant.
A new basis for reducing the value placed on a business in divorce has been put in the spotlight by a recent case in the High Court: E v L [2021] EWFC 60 (Fam), in which the Judge took the experts’ valuation but applied a significant discount of 45% when deciding the amount which should be shared with the spouse.
Background facts in the case
The marriage was a short one (lasting around 3 years to separation but 5 years up to the court date) and the parties did not have any children together. The wife was 61 and the husband was 66. The husband was very wealthy, having led a successful career as a production manager for music events and brought significant wealth into the relationship. The wife was an ex-model and swim-wear shop owner turned homemaker.
Valuation of ‘Company A’
The husband had various companies, one of which was a private company (relating to his music events and production work), with a significant value in which he held 100% of the shares. The Court considered the valuation of this company focusing on the proportion which had grown during the parties’ 5-year marriage and would therefore be shareable on divorce.
The business was valued by several experts and the court found that the ‘enterprise value’ (the reasonably foreseeable future maintainable earnings multiplied by the estimate of how many years of earnings a notional purchaser would pay for) was $5,067,500 at the beginning of the relationship and $10,860,000 at the time of the trial, making the marital element $5,792,500.
Mr Justice Mostyn decided that the end value (i.e. $10,860,000) should be substantially discounted (by 45%) to $5,973,000 (thereby decreasing the marital element to $906,000). That figure converted to sterling and net of tax was £518,000. The discount was applied for four main reasons:
- The impact of Covid-19 (the business related to music performances and there was uncertainty around if and when revenue would start to resume and in what amount) – this will (hopefully) be of limited relevance in the longer term now that we are no longer blighted by lockdowns.
- The husband’s business partner would be hands-on in earning a proportion of the sale value and the product of his endeavour was not something which should be shared with the wife.
- The single joint expert confirmed that business owners work their hardest in the couple of years leading up to a sale of their company than at any other time. The valuation therefore must factor in that work having been done when in reality the husband would put in all that effort to keep the business performing at a high level throughout the lengthy due diligence process carried out by a potential buyer to ensure an ‘orderly handover’ and ‘the preservation and promotion of the skills and reputation of the business’ and ultimately achieve the sale price confirmed by the valuation. At the time of the divorce that work had not been done. The Judge said that this therefore amounted to ‘post-separation endeavour’ which should be reflected by a discount in the value which is shared with the wife.
- The future maintainable earnings of the business (which form the basis of the expert’s valuation) were linked to the husband’s earning capacity and the future success of the business would to some extent depend on the husband’s future work. Future income is treated differently to capital assets already accrued on divorce and spouses have no entitlement to share it, it is only a needs-based claim. The Judge felt that the business valuation included an element of capital value for the husband’s ongoing work and attributes, which should not be shared on divorce.
The court added the discounted enterprise value (£518,000) to the increase in value of the company’s surplus assets (£2,533,996), bringing the total marital element of the value to £3,051,996, This was then shared equally with the wife, along with the other marital assets.
The difficulties involved in the valuation of businesses in divorce proceedings
The Court conducted a broad discretionary analysis of fairness, taking into account all the facts of the case, to arrive at this outcome. The case emphasises the inherent difficulties involved in the valuation of businesses, which the Court also discussed at great length.
In particular, Mostyn J commented that the valuation was based on an educated and informed guess about a hypothetical future (i.e. the future maintainable earnings of the company multiplied by an estimate of how many years of such earnings a purchaser would pay for). Mostyn J went on to say that valuations should be based on facts and known events, that being the best way to achieve a fair outcome. His discount achieved that by factoring out of what would be shared, the value of the husband’s work that was yet to be done.
Whilst a discount for Covid-related disruption is a temporary issue, the wider application of the other basis for the discount are significant and could apply to any business valuations used in divorce proceedings. The level of discount applied for each of the 4 reasons was not specified but we anticipate this will be a focus in many cases in the future.