What discounts can you apply when valuing a business on divorce?
It can often be difficult for parties to agree the value of a business when seeking to agree a fair financial settlement in divorce. Whilst debates can focus on the method of valuation, parties can also get bogged down in the details of whether discounts should be applied to a valuation.
In the famous case of Miller v Miller; McFarlane v McFarlane [2006], Lord Nicholls described business valuations as “often a matter of opinion on which experts differ”. This firmly positions the concept of valuation, in this context, as an art rather than a science.
Business valuation is a process where multiple arguments can apply and instructing a forensic accountant to act as a jointly appointed expert in a case is often advisable. The Court has also provided guidance as to which arguments can have greater or lesser weight, and established the most common situations where discounts can apply.
Minority shareholding and illiquidity
If one of the parties has a minority shareholding in a business (i.e. they own less than 50% of the shares in a company that have voting rights attached), then a discount will generally be applied to the valuation of this shareholding. This is to reflect the fact that the minority shareholder will not have the same degree of control over the running of the business in comparison to a majority shareholder. The final percentage of this discount differs on a case-by-case basis, but it strongly impacted by whether or not the business can be classed as a “quasi-partnership”.
What is a quasi-partnership and what impact does it have when valuing a business on divorce?
A quasi-partnership is a company that has been formed on the basis of a close personal relationship between the shareholders. Although the business is a limited company in the same way as a large business, its treatment for the purposes of valuation should be closer to how partnership would be valued and no minority discount should be applied, if the minority shareholder would only sell their shares as part of an overall sale of the company.
What does “illiquid” mean?
Shareholdings in a business, whether they be minority or majority, are regarded as illiquid in nature (i.e. not easy to convert into cash without losing value) in comparison to liquid assets (such as money in bank accounts or shares). The Court has shown a willingness to not treat liquid and illiquid assets as like for like and apply a discount to the value of illiquid assets, such as company shares in financial proceedings.
Covid-19, Brexit and Competitor Companies
In the recent complex case of OG v AG [2020], it was considered (amongst other issues), how Covid-19 and Brexit could impact on company valuations. As a very brief summary, this case involved a ducting company (X), which operated from the UK and an EU member state. Following their resignation from this company, one party set up a rival trading company (Y).
In this case, Mostyn J applied a 10% discount to the trading value (but not to the surplus assets) of X on the basis of Covid-19 and Brexit, then made a further 30% discount to the trading value (not to the surplus assets) of X due to the impact of the party setting up a competitor. These discounts were specific to the particular facts of this case, but show a willingness of the Courts to take these seismic events into consideration.
Given that the long-term impacts of both Covid-19 and Brexit are unknown at present, it is difficult to foresee how long these arguments will be relevant to discounting business valuations. However, this is a clearly an issue that the Courts will have to deal with regularly in the near future and will be highly relevant to individuals with business interests on divorce.
If you have any questions about valuing a business on divorce, please get in touch with our team who would be happy to assist.
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