The effect of COVID-19 on Business Valuations in Family Law – Podcast Episode 9

Before negotiating or litigating a family law settlement all assets (including any business assets) need to be valued, either by the parties ascribing an agreed value of appointing an expert accountant to independently value the asset. However, in light of the current COVID-19 crisis and the Australian and Victoria government’s response (where we have seen whole industries limited in their ability to trade) how are expert accountants valuing small to medium sized businesses in the current economic climate?

 

Nadine Udorovic:

Welcome to the Nicholes Family Lawyers podcast. This is yet another episode in the fourth podcast in our series. My name is Nadine Udorovic and I’m a partner in Nicholes Family Lawyers. I’m joined today by Kate Bell, Senior Associate. Today we are talking about the way the COVID-19 pandemic is affecting family law, business valuations family law purposes and how we, as family lawyers, are adapting to this changing landscape. Before we start, a bit about our firm.

We are a boutique family law firm located in the Melbourne CBD around the corner from the family court. We look after clients from Metro areas, rural interstate and internationally. Our areas of expertise include complex parenting and financial matters and international family law matters such as child abduction, adoption and surrogacy. We provide advice in relation to intervention orders, finding financial agreements or prenuptial agreements and child support matters. But today, for our clients operating or involved in business will discuss specifically the impact of COVID-19 on family or property settlement negotiations. It is definitely not business as usual. And to look at the challenges posed by the current climate, we’ll discuss the following: How a court approaches a property settlement, how a business valuation is relevant to this, the current factors to consider when valuing a business and how do these factors impact a business valuation. And now I’ll hand over to Kate who will talk about property settlement in the Family Court.

Kate Bell:

Thanks, Nadine. As a background, let’s first explain how the family court approaches property settlement. The first step is to consider whether it is just inequitable to make any orders in relation to property in the first place. Section 79 subsection 2 are the The Family Law right, requires any property orders made by the court to be just inequitable. This section is treated as a statutory precondition before an order, which are just a party’s legal interest in property can be made. This means that the first step the court will take is look at the current ownership of property and ask, “Is this just inequitable the way it is? If the answer is no, the court will move to the next step, which is to calculate the net asset pool. The court must identify and value all of the property belonging to the parties to the marriage or relationship. The general rule is that all assets must be taken into account whether they were acquired before or during the relationship or after separation. These assets may be dealt with differently depending on when they were required. However at this step, the court will consider all the assets.

Property can include real estate, cars, cash, shares, businesses, superannuation, chattels, trusts, inheritances, long service leave payments, compensation payments and lottery wins. Superannuation interests of the parties are also now deemed to be property for the purposes of matrimonial or de facto proceedings. The family court also has the power to split superannuation interest between parties. That is to transfer a portion of one party superannuation to the other party. The family court values all assets of the parties as at the date of trial, minus any liabilities of the parties. That figure equals the net asset pool. The court must also consider the financial resources of the parties, which includes funds or assets over which a party has influence or control. Financial resources provide a future financial benefit to one party and can include pension entitlements and interest in a deceased estate and family discretionary trusts.

The third step is to consider the retrospective contributions that each party has made to the acquisition maintenance or improvement of property. Initial contributions recognized by the court include financial contributions such as having funds or property at the beginning of a relationship, which were then applied to purchasing other property during the course of that relationship. Other financial contributions include any income earned or gifts or inheritances received, which were then contributed to the acquiring or improvement of property. The court also looks at contributions of a non-financial nature such as building, renovating or improving a property using your own skills or labor. The other category of non financial contributions recognized by the family court, a contributions made to the welfare of the family and the capacity of a party as a homemaker and/or parent. Child rearing and homemaking contributions are often treated as equal to financial contributions. However, this will depend on the length of the marriage.

After considering retrospective contributions, the fourth step is to consider each of the parties future needs. Depending on those, if the court considers it appropriate, it will allocate a greater share of property to one spouse than they might otherwise have received on a contribution basis alone, such as the age and health of each of the parties.
Another factor would be the length of the marriage and the ability of each party to gain employment post-separation. For example, if you have been a homemaker for the majority of your life and you split with your partner at the age of 50, it would most likely be difficult for you to re-enter the workforce. The court will also consider the disparity in each party’s future income and ability to earn income. Other factors also include whether each party has the care of any children of the marriage who are under the age of 18 and the need to protect the party who wishes to continue their roles as a parent. The court will also take into account any other relevant factor circumstance in determining whether an adjustment to the division of the property pool is required, such as any wastage arguments that may arise.

The final step involves the court taking a step back to ensure that the intended orders are just and equitable in all the circumstances. The court will also assess the practical effect that the orders will have on the parties. Each case needs to be decided on its own facts, but by questioning whether it would be just and equitable to make the orders at both the beginning and end of the property settlement process. This ensures the parties will receive a fair outcome based on the specific circumstances of the relationship or marriage.

Nadine:

For many families, in addition to the family home, a business asset is often the most significant asset of the marriage. It may also be the sole income-producing asset of the relationship. It might, in effect, feed the family. It is important to obtain an accurate business valuation when involved in settlement negotiations, as in general terms you get one go at a property settlement and is just to do it right. While the situation with respect to COVID-19 continues to evolve, the effect on businesses and therefore the flow on effect on business valuations and impact is property settlements is significant. As the Australian government continues to implement measures related to social distancing and isolation, issues surrounding supply chain, workforce and cash flow will affect business valuations.

There are both positive and negative factors arising from COVID-19 that will affect a business valuation including the following: Store or facility closures, retail stores such as Country Road or Myer and many other smaller retail outlets. Loss of customers or foot traffic such as cafes, bars and restaurants, which have temporarily lost the ability to offer dining services and if able to, are only able to offer limited takeaway options, therefore significantly reducing revenue. Retail, hospitality, entertainment and nightlife operations have been hit significantly hard as the majority of their customers and employees engaging face-to-face communication and not in this new virtual land.

Online retail, while still available, is also not appealing to all ages of society, not available to all members of society who may not have access to credit card facilities. And increase in customer defaults as customers purse strings tighten, so might their ability to make payments under contractual obligations to the business and impact on supply chain might mean a business cannot provide a customer what they need. For example, many retail stores, source and make various items overseas and given the impact on supply chain, they may not be able to have stock and merchandise shipped to Australia to fulfill customer order. The impact on the workforce, employees stood down or retrenched, will have an impact on the value of the business. The risk of loss of significant contracts think corporate training or education or training organizations that may have lost several contracts due to financial constraints, but more so social distancing requirements as they are able to facilitate face-to-face training models.

On a positive side and there are positive indicators that also need to be taken into account. They will indicate the viability of the business beyond the COVID-19 crisis. These include the impact of government support measures were eligible such as to $1,500 job keeper scheme to subsidize wage costs, payroll tax waivers or refunds, business support loans, PAY cash flow for employer payments, ATO tax deferrals, legislative limitations on landlords evicting tenants and the ability to renegotiate rank terms, the ability to convert fixed expenses to variable expenses such as rent relief or rent free periods, changing mortgage payments from principal to interest only or a holiday from repayments for up to six months. Management may be required to conduct appropriate negotiations with suppliers or clients regarding the renegotiation of payment terms, which may be interim to deal with reduced cash flow in the coming months. Then longer-term factors such as the economic recovery predicted for a particular sector and whether the business will be able to return to levels in line with historical performance, which I will discuss a little bit later where I talk in more detail, in terms of various options for valuations of specific businesses.

Kate:

Yeah. It’s interesting. These current challenges highlight the many factors that come into play when value was asked about your business. Evaluation isn’t that dissimilar to fresh fruit. It has a use by date and it’s going to grow stale with age. We’ve never seen a crisis spread so quickly. As such, evaluation obtained at the commencement of a property negotiation three, six or nine months ago will no longer be relevant today. Evaluation only takes into account economic and other conditions existing as to the valuation date. It is almost 30 days since we’ve first felt the effects of COVID-19. As such, business and other valuations such as real estate valuations will need to be a reassessed as to their relevance today, given the unprecedented changes to our economy in the last month.

For existing cases where business valuations have been previously obtained, a value would need to consider how COVID-19 has affected the business. This is where forensic accountants or specialist accountants are invaluable tool in providing the most accurate assessment in circumstances. However, even forensic accountants agree that there may be a large disparity of assessments and divergence in opinions in these current circumstances, given the uniqueness of this crisis. Different to the Great Depression, the 81 stock market crash in the 90s recession we had to have, this is a health-related crisis, which has effectively shut down country’s economically as well as society as well. Also it appears that in order to meet the crisis, the public sector is assuming many of the obligations of the private sector. This is a move that would never been contemplated previously. Nadine?

Nadine:

What does this all mean for valuing your business? From the outset, we must stress that not all business valuations will be negatively impacted by the current circumstances. Some businesses operating industries that are thriving in the current climate by virtue of a demand from particular product or service. For example, many Tech IT security businesses are booming due to the unusually high demand for online assistance around the globe. IGA and many other supermarkets have a sustained increase in sales that outstripped their usual Christmas period. So whilst current cash flow might be reduced or halted completely for some businesses, during this period for some it might have increased. Secondly, the rate of recovery after the crisis will be dependent upon the nature of the business involved.

Broadly speaking, there are three types of business recoveries. For those visual types, these can be characterized as a V, U or an L recovery. A V-type business will bounce back almost immediately after the crisis. Think a dentist who after the crisis is over reopen her doors, will reopen their doors and will pick up where they left off with regular check-up and on-demand dental work or others within the beauty industry. Then there are the U-shape businesses, which due to a relax on a supply chain might have a period of lag or adjustment, whilst the supply chain reactivates to meet the demand. Then there is the last type of business, the L business, that will not be able to adapt to the challenges posed by the crisis and will re-struggle to restart after the crisis. The COVID-19 pandemic will affect each of these businesses differently and will need to be taken into account in valuation methodology.

Bearing in mind the above, when evaluation is obtained, ensure the economic and wider assumptions underpinning the business valuation reflect the current circumstances. Be wary that new valuations obtained now do not overstate the valuation impact of COVID-19 as they should incorporate a longer-term view of earning. If the fundamentals of the business of strong, the valuation should reflect a strong future forecasts for the business. And also bear in mind that it may be appropriate if you are provided with evaluation you do not believe accurately reflects the value of your business, taking into account past, present and future factors, you may be advised to obtain your own valuation or a second opinion to critique the valuation, to ensure that the negative impact of COVID-19 has not been overstated in the valuation. Whilst the situation continues to evolve and change daily at this stage, we suggest there may be three possible options with valuations of businesses and relevant entities at this time.

Option 1, a limited scope valuation pre COVID-19 value. On the 11th of March 2020, COVID-19 was declared a pandemic by the World Health Organization. It is a worldwide event and at this stage is not possible with any degree of accuracy or certainty to predict the economic and financial implications that will arise. Accordingly, the extent of impact on value of a business and entities is not known. Therefore, the valuation provided would need to be considered as pre COVID-19. For example, this may be looking at the financial statements up until the end of March 2020 and not later.

Option 2, a limited scope valuation with the adoption of a discounted cash flow approach to attempt to model and reflect potential ongoing financial impacts of COVID-19, the valuation of each of the businesses or each business or entity could be undertaken, applying a discounted cash flow methodology with the approach attempting to model the financial impact on cash flows of current events relating to COVID-19. This would be considered a limited scope valuation under the standard and would need to incorporate a range of assumptions. A number of these assumptions, for example, the length of time the financial effect is felt could be subject to a degree of uncertainty.

Option 3, a further option would be for a valuation opinion on the basis of both option 1 being pre COVID-19 value and option 2, value reflecting the current COVID-19 circumstances adopting a discounted cash flow approach. Providing values under both options would likely provide parties with a spectrum of value and provide informed perspective of value in an uncertain time, which could assist to continue negotiations and seek resolution of family law matters as a result.

Finally, once you have obtained evaluation and proceeded to the negotiation stage, the asset pool is agreed and the distribution between the parties is settled upon, we highly recommend documenting any settlement reach by way of professionally drafted court orders, that will ensure the compliance in terms of settlement, provide an avenue for enforcement and a barrier to the other party to seeking a further property settlement in the future. After all, no one wants to spend months crafting a settlement to have it fall over due to lack of documentation or poorly drafted documents.

In conclusion, we work with a trusted team of accountants, commercial lawyers, forensic accountants, valuers to assist parties in reaching and documenting both simple and complex property settlements. If you have an accountant or legal advisor, we can work with them in a holistic way to ensure minimal impact to your business possible during family or settlement negotiations and ultimately business valuation.

We hope this podcast has provided you with some insight regarding the importance of obtaining an accurate business valuation for the present time. Most importantly of all though, during these unprecedented times, stay safe and stay well.

Kate:

Yes. Thanks for listening. Stay well. Bye.

 

Disclaimer: Nicholes Family Lawyers intends the information provided in this podcast as general information only, please contact Nicholes Family lawyers if you require specific information and advise in relation to any family law matter.

 

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