Challenging business valuations in family law

Arnold Shields
Dolman Bateman & Co Pty Ltd
Forensic Accountants
www.dolmanbateman.com.au
Challenging business valuations in Family Law

Fundamentals
Value of an asset is a function of it's future cashflows
What is value? Different concepts of value.
Family Law = Value to owner
Value = Cashflows x risk
Income based valuations assume infinite life of business but discount rate means value after 10 years is negligible.

5 Basic Valuation Methodologies
discounted cash flow,
capitalisationof future maintainable profits,
notional realisation of assets,
value of net tangible assets (on an ongoing concern basis)
capitalisationof future maintainable dividends.
– Wilde & Wilde [2007] FamCA 1044 (6 September 2007) at 154

Discounted Cash Flow (DCF)
Summary
The discounted cash flow (DCF) value is the present value of the expected future streams of cash flows discounted at a rate which reflects interest rates and the risk associated with the business.

Discounted Cash Flow (DCF)
Pros:
Considered as the most accurate method
Basis for all other valuation methodologies
Cons:
Rarely is information required available.
High level of assumptions required
Misunderstood

Future Maintainable Earnings
Summary
Value of Business is equal to Future Maintainable Earnings x Capitalisation Factor
Value of Business is not Value of Company
Will use past earnings as a guide for future profitability.

Process of Future Maintainable Earnings
Identification of tangible assets and liabilities
Revaluation of assets to market
Separation of balance sheet into business assets, surplus assets and financing liabilities.
Determination of future maintainable earnings
Determination of capitalisation rate
Value of business = FME x Cap Rate
Goodwill = Value of business less Net Business Assets
Value of Company = Net Business Assets + Goodwill + Surplus Assets - Financing Liabilities

Future Maintainable Earnings (FME)

Future Maintainable Earnings (FME)
Pros
Easily understood
Commonly Used
Fewer assumptions than DCF
Cons
Difficult to apply to high growth companies and those with abnormal capital expenditure requirements

Net Realisable Assets
The value of that shareholding is normally no less than that shareholder’s proportion of the estimated realisable value of the net assets of the company.
The notional realisation of assets basis of valuation is normally only applied to businesses which do not produce an annual cash flow, or where, the outlook for a company’s future earnings is either uncertain or the capitalised value of such earnings is less than the net realisable value of the assets employed.

Future Maintainable Dividends
Summary
The value is equal to present value of the future maintainable dividends discounted at a rate which reflects interest rates and the risk associated with the business.
Used in minority interests only.

Future Maintainable Dividends
Pros
Used in minority interest valuations only, but other methodologies available.
Cons
Does not take into account retained earnings
Dividend rate may be subject to other non-commercial considerations (payroll tax)

Definitions of Value
Value to Owner – “The concept of “value to owner” considers and takes into account the benefits to a particular owner even though this may not be based on a hypothetical third party purchaser.” Scott & Scott (2006) FamCA 1379 at 45:
Fair Market Value - 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.
Special Value – value to a particular purchaser - takes into account synergistic benefits
Book Value – value recorded in books

Common mistakes
#1 - Maths - the numbers just don't add up
#2 - Two sets of books
#3 - Rules of Thumb
#4 - Methodology incorrectly applied
#5 - Concept of Value - Value to owner
#6 – Independence
#7 - Adjustments to Future Maintainable Earnings

Maths Errors
Examples
Valuation does not add up
Critical Ratios incorrectly calculated (Sales Increase, Gross Profit %, Operating Profit %)
Balance Sheets, Profit & Loss incorrectly summarised.
Wrong amounts used in FME adjustments.
Balance sheets not balancing
Assets and Liabilities missed

Two Sets of Books
Management Accounts, Financial Statements, Tax Returns are all different
One version for Bank and another for Tax
Incorrect Accounting Treatment of Transactions
Cash not declared
Intercompany Accounts not agreeing

Rules of Thumb
ROT
No evidence to support basis
Used by Business Brokers to support price
Uneconomic returns
Often include owners salary ie. Buying a job

Treatment of Surplus Assets andFinancing Liabilities
What are Surplus Assets?
Excess cash, property, investments, intercompany loans, directors loans.
Financing Liabilities?
Bank Loans, Bank Overdrafts, Directors Loans
Hire Purchase, Chattel Mortgage, Leases ?
Security over personal or other non-business assets

Capitalisation Rate
Have reasons for opinion been given?
Positive Factors
Negative Factors
Within Reasonable Range

Future Maintainable Earnings
Basis of Future Maintainable Earnings
Reasons for basis
Past earnings are used as a guide to estimating performance.
Sufficient Analysis of Business
Adjustments
Surplus assets
Fringe Benefits
Non-recurring income and expenditure

Commercial Salary
Basis of Commercial Salary
Evidence – Salary Survey etc.
Are they qualified to give opinion in this area?
Base Salary or Total Package including Fringe Benefits such as Motor Vehicles

Summary
Does the valuation use an accepted method of valuation?
Has the valuation methodology being correctly applied?
Does it add up?
Have reasons being supplied for opinions?
Are reasons for opinions (FME & Cap Rate) supported by evidence?

Questions?
Arnold Shields
Dolman Bateman & Co Pty Ltd
Ph: 02 9411 5422
Email: ashields@dolmanbateman.com.au
Website: www.dolmanbateman.com.au

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Challenging business valuations in family law

by Dolman Bateman on Aug 16, 2010

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Challenging business valuations in family law — Presentation Transcript