Valuation Issues in Divorce

Demystifying Valuation, Economic Damages + Forensic Accounting

Divorce can be a very emotional event, which is further complicated by the effort to equitably divide the marital assets. The parties often disagree about the value of specific assets; which assets are sole and separate property; and on occasion, may accuse one another of fraud. One particular item that is often in dispute is the value of any closely held businesses.

Unlike publically traded companies, which have a traded per share price and published financial data, closely held businesses are more of a mystery to outsiders. One of the jobs of a valuation expert is to unravel this mystery, using the financial records of the business along with the analytical tools available to the valuator. Three approaches are normally utilized in the valuation of a closely held business:

  • Income approach – examines the projected income producing ability of the business.
  • Asset approach – examines the assets and liabilities of the business.
  • Market approach – compares the business to others in its industry.

Once a value has been determined under each approach, the valuation expert will decide how much weight to assign to each method, if any, and then a final value conclusion is reached. As valuation is both an art and a science, no two valuators will arrive at the same value conclusion. The valuator must also always be cognizant of the possibility that one or more of the parties may be falsifying records in an attempt to protect what they perceive as their asset(s). Another issue that may arise during a divorce is the determination of sole and separate property.

Arizona is a community property state, but there are specific circumstances under which parties may still hold sole and separate property. One example would be a lump sum inheritance received by wife prior to the marriage. The determination of sole and separate in this situation can be complicated, especially if the marriage was long term and the inheritance was stored in an account where it co-mingled with funds of the marital community. This is a situation in which the valuation expert must trace funds to determine if the balance in the account consists of the sole and separate inheritance or if the inheritance was depleted and the remaining funds are actually community property. Poor record keeping in combination with a lengthy look back period can complicate this issue even further. Once again, the valuation expert must always be aware of the possibility of fraud when examining transactions and reviewing records.

In the case of fraud, either party, in a misguided effort to protect assets they perceive as theirs, may engage in the alteration or destruction of financial records. In addition, either party may accuse the other of fraud in relation to both business and personal finances. The valuation expert must be aware of this risk throughout the valuation engagement, and may be engaged specifically to perform forensic accounting procedures in response to a fraud claim.

One of the desired outcomes in a divorce is the equitable distribution of assets. In order to determine an equitable distribution, the value of those assets must be known. In addition, the parties must resolve issues regarding sole and separate property, as well as possible fraud claims.

By Shyla A. Ingram, MSA