The first step in any family law property settlement is to identify and value the assets
belonging to each party.
A business is an asset and its value either needs to be agreed between the parties or valued
by a qualified expert.
A business, like any asset, is to be valued at its fair market value which is defined as:
“the price that would be negotiated in an open and unrestricted market between a
knowledgeable, willing but not anxious buyer and a knowledgeable, willing but not
anxious seller acting at arm’s length”.
The Family Court of Australia has noted that there are five main ways in which a business
can be valued. These methods are:
- Capitalisation of future maintainable earnings;
- Value of net tangible assets (on an ongoing concern basis);
- Discounted cash flow;
- Notional realisation of assets; and
- Capitalisation of future maintainable dividends.
Different businesses will require different methods of valuation. All are complex and require
specialised advice from an expert valuer (usually a forensic accountant) before a value can
be prescribed. Each valuation method is briefly summarised below:
Capitalisation of future maintainable earnings
The Capitalisation of Future Maintainable Earnings is the most common method used in the
valuation of profitable businesses. This method values a business based on the level of
profits that are likely to occur in the future. It uses the past performance of a business to
calculate the likely future performance and is therefore only appropriate where the level of
future profits is expected to be stable. Often the average of the previous three years is used to
estimate the future earnings of a business. The future maintainable earnings are then multiplied
by the “capitalisation factor” which then converts the anticipated profits into a valuation. An
example is that if a business has an expected future profit of $100,000 and a capitalisation
factor of 3, the business would be valued at $300,000.
Value of net tangible assets
The value of Net Tangible Assets method is used when the business does not generate a
sufficient profit and values the business based on net value of the tangible assets of the business.
Discounted cash flow
The Discounted Cash Flow method values a business based on the value of its expected future
cashflows discounted by return and risk. Cash flow is projected over time. The main difficulty in using this method is that there is rarely all the necessary information available without making assumptions which is why the Future Maintainable Earnings method is more commonly used.
Notional realisation of assets
The Notional Realisation of Assets method is used when the business will likely cease trading.
The valuation is calculated based on how those assets will be sold (i.e. through a normal sale,
liquidation or ‘fire sale’).
Capitalisation of future maintainable dividends
Rarely used, the Capitalisation of Future Maintainable Dividends is used when a minority
shareholder does not have access to the undistributed retained earnings and such a pattern
has been established in the past.
While lawyers cannot provide accounting or valuation advice, an accredited specialist in
family law who understands business valuations and the methods that can be utilised to
value a business can identify business valuation issues early which will save significant time
and money to enable the best outcome to be obtained.