In the sometimes contentious realm of divorce proceedings, the role of forensic services becomes increasingly vital. Last month’s article, “Valuation of a Business for Divorce: Overview of Valuation Approaches and Normalizing Adjustments,” shed light on the complexities of valuing a business, describing the three approaches: the asset-based approach, the income approach, and the market approach. The article also emphasized the importance of “normalizing adjustments” which act as a corrective lens, adjusting the income statement to portray the financial results from the ordinary operations of a business, as well as ongoing earnings capacity of the business.

Valuations of a closely held business in the context of a contentious divorce can be especially multifaceted and may require additional forensic investigative scrutiny for any irregularities in the financials in anticipation of the divorce and valuation. In valuations for divorce, certain adjustments may impact and/or require further forensic services such as income determination, tracing services, lifestyle analyses, marital vs. separate analyses, and more.

Examples of such adjustments may include, but are not limited to:

  • Owner Compensation. Owners may reduce earnings in anticipation of divorce to appear to have lower earnings capacity. Owners or executives with ownership interest may have made arrangements within the business to receive a post-divorce pay-out. A financial expert, through review of historical financial statements and tax returns, as well as an analysis of the lifestyle of the family, may gather support of the true earnings.
  • Rent expense. Owners of a company may also own the land and/or building to which the business’ rent expense is paid, otherwise referred to as a related party. If the rent has increased in anticipation of the divorce, the related party may be taking on pre-paid rent or higher than market rent rates to reduce income. A financial expert may review historical expenses and assess the reasonableness of the rent expense.
  • Discretionary expenses. Owners may use business funds to pay for personal, non-business related expenses such as vacations, lavish cars, boats, meals & entertainment, among others. A financial expert can review historical transactions to assess if such items are non-business related and if normalization adjustments are necessary for valuation purposes.

It is important to consider these types of situations if only one spouse is involved with the operations and management of the company, otherwise referred to as the “in-spouse.” That spouse may, or may not, have been altering the financial position of the business in anticipation of divorce and a potential independent business valuation. The services of a financial expert can be vital to you and your client in such matters, as the accuracy of the valuation may impact the equitable distribution of the marital assets.

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