How should an appraiser value businesses in a divorce? What happens to those valuations during an economic downturn such as the COVID-19 crisis?
In our most recent webinar, industry experts Ken Pia, CPA, ABV, ASA, MCBA of Marcum LLP, and Mitchell Cohen of Johnson & Cohen, LLP answered those questions while they covered the following topics:
- How the market has affected the multiples used in valuing a private company and the impact on short-term discount rates
- How the date of the valuation affects value
- How transaction data in the private mergers and acquisitions (M&A) markets affect current business valuation multiples
- How rates of returns in the public market affect the income approach to valuation
- How you might adjust a company’s cash flow during an unpredictable economy
- Legal impacts on divorce cases
Mr. Cohen cited examples of New York case law for setting dates of valuation. The concepts can apply to other states. Per Empire State rules, courts set the date or dates of valuation of each asset, which can be anytime from the date divorce proceedings start to the date of trial.
Some states, including New York, use fair market value as a standard for asset valuation, defined as the price expressed in terms of cash equivalents, at which property would change hands between a hypothetical willing and able buyer and seller. The transaction occurs “at arm’s length in an open and unrestricted market, when neither is under compulsion to buy or sell and when both have reasonable knowledge of the relevant facts.”
Mr. Cohen and Mr. Pia have encountered cases in New York that use an alternative standard of value known as “value to the holder” (investment value – intrinsic value). The value doesn’t belong to a hypothetical buyer but to a specific buyer – the current owner. It usually comes up when there’s an inability to transfer an interest or sell a company or business. Mr. Pia sees it often with large law firm interests. Courts have said that just because a business or interest isn’t transferable, it doesn’t mean it lacks value to the holder. Going forward, the business owner will be able to enjoy cash flow and other benefits “over and above their normalized reasonable compensation.”
The valuation hinges on future expectations of value. When the valuation date has been agreed upon, the expert’s assessment is based on “facts known and knowable as of that date.”
How Has the COVID-19 Pandemic Affected Business Valuations?
The COVID-19 crisis can influence valuations if they’re tied to the valuation date and evidence shows the economic downturn occurred after the original appraisals.
Mr. Pia said it comes down to whether the pandemic was known or knowable. For example, a valuation as of 12/31/19 will show the state of the economy and markets then. If the appraiser didn’t know about the pandemic on 12/31/19, they can only consider what was known or knowable on that date. But, if the appraiser issued the valuation today, it will have a subsequent event provision that states what we know has happened since 12/31/19, but wasn’t known or knowable as of that date. Therefore, the appraiser can’t base their valuation on other factors (declines in market rates, multiples, etc.) in any jurisdiction. “When you have a cut-off date or date of commencement valuation date and things have changed since then, you need to update your valuations and think about what has happened since 12/31/19 compared to what we know now.”
As Mr. Cohen added, we’ve survived other economic downturns before, but nothing compared to the Great Depression until now. It’s hard to predict when we’ll recover from it.
If you’re starting a case now, consider whether to postpone it and the legal intent of valuation or valuation dates. The valuator’s duty is to ensure that each spouse receives a fair and equitable share.
Mr. Pia then explained:
- variables that affect business value
- valuation theory and how it relates to the COVID-19 pandemic
- different valuation methods, including the income approach
- variables that affect valuation methods now
He offered a “decision tree” to help appraisers decide how the pandemic can influence valuation and a settlement. The answers to the questions he poses reveal the business owner’s expectations for a rebound and how the recovery period might unfold.
Mr. Cohen added that business appraisers must make subtle valuation judgment calls, which is why it helps to talk to an expert, especially when you cross-examine witnesses. More variable factors exist now versus six months ago.
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DISCLAIMER: We offer the webinar for informational and educational purposes only. It shouldn’t be considered legal, accounting, or valuation advice.