As family solicitors, we are often asked how businesses/business assets are divided on divorce or dissolution of a civil partnership. Whilst there are no hard and fast rules when it comes to dealing with an individual’s business interests, the below sets out some key considerations for dealing with private limited companies.
Dividing businesses can be a minefield, and there are of course many other considerations not mentioned in the outline below. Contact our Family team today to discuss how we can assist you in protecting or dividing your assets.
Understanding limited companies on divorce
It is important to understand who the shareholders and directors are. Most of this information can be found on Companies House.
We would also need the full accounts for the last few years to give an indication of its assets and profit.
Whilst we will never be experts when it comes to our clients’ (or their spouses’) businesses, lawyers should have a basic understanding of the nature of business in question, what it actually does and how it operates. Why is this necessary? FOR SO MANY REASONS. For example, if the business is in a sector that is known to be facing challenges, this is a factor that may impact on its value. This was extremely important during Covid-19, as there were some businesses which were simply unable to operate as usual (for example, pubs, restaurants, theatres, and even dentists) and depending on their accounting period, the full impact of this may not be reflected in the latest accounts.
It is absolutely vital that you appreciate the impact current events and market conditions may have on the businesses you are dealing with. Where a company’s value is effectively money in the bank, there may be times where the bank account is particularly healthy or conversely, very unhealthy. So, if there is a company that has a time of the year where there is a significant peak or trough in cash flow this should be appreciated. Naturally this will be viewed alongside company accounts but understanding how a company operates and when it will need cash in the bank will assist when it comes to negotiation but more importantly, when considering timing of implementation of any agreement relating to the company.
How is a business valued in divorce?
In most cases, it is necessary to have a business valued before negotiating a divorce settlement. There are some companies we come across which will not need valuing. For example, when one of the parties is self-employed and simply uses a limited company as a vehicle to issue their invoices for services supplied. In this case, the company will often not have any intrinsic value and will be seen as simply an income stream. The capital value of such companies will usually be just the cash in the bank (although it should be noted that any withdrawals of cash, will attract tax).
Other companies will have a value and depending on the circumstances it may be necessary to obtain a formal valuation. The key thing to consider is proportionality. If a valuation is required, some details to consider are:
What type of business is it and which method of valuation is most appropriate?
This is the work of a specialist valuer and it should be appreciated that valuing companies is more of an art that a science. The standard bases for valuations of businesses are:
- Earnings approach – what is the maintainable future earnings (often used for a trading company). This will be based on history of profit (subject to certain adjustment) with a multiplier attached, which will be dependent on the sector.
- Dividend Yield approach – this is based on the payment of dividends and an appropriate rate of return to establish the value of a shareholding.
- Net Asset approach – is the company, for example, a property holding company? In this case, the valuation is likely to be based on the value of its assets
- Discounted cash flow approach – basing a value on a company’s projected future benefits
- Actual transactions – has any shareholding been sold in recent times and if so, what has been paid? This will give an indication of current share value.
Other things to consider and draw to the attention of any valuer are:
Are there any significant current market conditions that need to be considered? As stated above, it may be that the latest accounts do not reflect the current position so management accounts should also be supplied to the expert valuer.
If the shareholding is a minority shareholding, often a discount will be applied. This is because a minority shareholder will have less control over the company, which can be less attractive to a third-party purchaser. The percentage discount is subjective but generally the smaller the minority the more the discount. Such a discount would not apply if the minority shareholding was considered to be a Quasi Partnership (where the shareholders run the company more as a partnership). All the circumstances would have to be analysed before a conclusion on this could be drawn. The circumstances that could evidence a Quasi partnership are out of scope for this blog. without the consent of both parties. In such cases, the minority shareholding is not discounted.
Also, it should be appreciated that there are different types of shares, some may not have voting rights and/ or may not be entitled to dividends, or even only receive a pay-out if the company is wound up. This could all impact on value.
If the shareholding is a minority shareholding within a family company, it is possibly an unattractive proposition for an unconnected third party and hence the price would be depressed.
Are there any key personnel whose possible departure/retirement may have a significant impact on the company’s income.
This will largely depend on the circumstances of the case but if the company was set up during the marriage, the starting point will be 50% of the value of the company/shareholding. This is true even if only one party works for the company, and this is their primary source of income. There will of course be arguments that can be run to suggest a departure from equality, but it is imperative for parties to appreciate what the starting point will be from the outset of proceedings to avoid disappointment down the line.
This is the consideration that causes most headaches and yet is the one we see forgotten about most regularly. Most businesses do not have large cash reserves that can be withdrawn. Indeed, typically cash reserves are there to assist with the running of the business and to withdraw these would leave the business short of the necessary cash flow to operate. There may be no cash reserves at all and so it is always helpful to get a view on the liquidity of the business from the expert valuer (i.e. what can be withdrawn over what period).
One must also think about the tax consequences of taking funds from the business – you cannot simply release funds without tax implications; in most cases funds are extracted for shareholders as a dividend (and/or salary if they are employed by the company) and would therefore be subject to dividend/income tax.
It will always be necessary to seek advice from an accountant as to what is the most tax efficient option.
There are a number of different options available, and the most suitable will depend on the individual circumstances. Sometimes if the parties are both shareholders you could explore whether it is feasible for them to both remain shareholders, or even with a transfer to adjust the shares. If one party is not a shareholder, would it be an option to transfer to them shares in specie?
Don’t forget a transfer of shares may attract Stamp Duty. Further, any party disposing of shares may suffer a Capital Gains Tax liability. The tax payable will depend on which mechanism is used to transfer shares (e.g. straight transfer, company buy-back, or demerger), and advice should be sought early as to which method is most appropriate in the particular circumstances of a case.
If there are other non-company assets available that can be used instead (to offset) to pay a party what they are due from the company, this may be simpler, however this is not always the case.
Whilst it is imperative to be mindful of these complications, it is important to involve experts in any discussions from the outset.
How can Hanne & Co help you?
Advice should be sought prior to putting forward any proposals for settlement, to ensure such proposals can be implemented and any tax liability is properly factored in. We have a network of trusted advisers including accountants and company law experts who can assist you in your transaction.
Contact our expert family law team on 0207 228 0017 or through the contact form below to find out how we can assist you today.
Image Credit © [nataliaderiabina] / Adobe Stock