Posted: 30 / 08 / 2024

When a relationship (professional or personal) breaks down, there are often significant assets or business interests which need to be dealt with, accrued over the life of the relationship.

These assets or interests typically include a marital home but can also include shares in limited companies, partnerships, or smaller sole trading entities. When a separation occurs, these marital assets normally need to be valued in order for a fair financial settlement to be reached.

Valuation expertise is often required to value these marital assets which in the case of a marital home, would clearly be done by a surveyor or real estate expert. However, in the case of assets such as business interests, other valuation expertise will be required.

Although there are multiple ways to value a business, there are three key valuation methods or approaches that are commonly used by valuation practitioners: the Income Approach, the Market Approach, and the Cost Approach.  Each of these approaches has distinct advantages and disadvantages, which we discuss below.

Income Approach

The income approach is an intrinsic valuation method in the sense that it is based on the value of an asset or business’s income-generating potential alone, not relative to any other assets or businesses.

Typically, the benefit of owning an asset or business is the future cash flows or profits of that business. These future cash flows can seem to have a current “present value.”

This present value reflects the idea that £1 today, is worth more than £1 in the future.  £1 today can be invested or saved in a bank account, gaining a return or interest, furthermore, there’s no guarantee of delivery of £1 in the future.  The difference in value between money now, and money in the future is captured in a “discount rate” which is dependent on a number of business and industry specific factors such as the maturity of the business, the returns from similarly performing public companies, and the location of the business.

As the income approach estimates the present value of future cash flows or profits, this can often require the availability of forecasts and therefore a more sophisticated finance function within the company being valued.  On this basis, this approach isn’t always appropriate and it can be difficult to value companies which don’t (or wouldn’t be expected to) generate long term forecasts of their expected cash flows.

Market Approach

In contrast, the Market approach is a relative valuation method, using comparable assets or businesses to determine a value for the target company.

The general principle of the market approach is that the “market” has done the legwork for you and that a prudent or rational investor won’t pay more for a given asset than they would for a comparable one of the same utility.

In our experience, the market approach is an appropriate method for valuing small to medium sized entities, which don’t have the sophisticated forecasts or projections to use the income approach effectively.

The market approach requires expressing the value of comparable assets or businesses as a ratio between their value, and some financial metric, such as revenue or earnings before incoming, tax, depreciation, and amortisation (EBITDA).  These ratios are referred to as “multiples”.

With a series of appropriate multiples determined, these can be applied to the financial metrics of the business to be valued.

For example, consider a business which sells widgets. If based on research of competitor widget companies, it’s determined that a 6 times EBITDA multiple is appropriate, the EBITDA of the target widget company (say, £250,000) will be multiplied by the 6 times multiple to reach an enterprise value of £1.5 million.

However, there can be a number of potential drawbacks with the market approach.  In particular, if there are few to no comparable companies then it can be difficult to determine an appropriate multiple.  Further, if companies in a similar industry are found, then various adjustments may need to be made to any potential multiple to account for issues such as if one of the comparable companies is public, whereas the valuation target company is a private company.

Cost or Net Asset Approach

The final and least common valuation method is the cost or net asset approach.  The method is based on the principle that the value of a business is no greater than the value of all its held assets if sold, and all its liabilities paid off.  The cost approach is essentially the value that should be realised if a business is shuttered and wound down.

Of the three valuation approaches set out above, the business value using the cost approach is likely to be the lowest of the three.  Essentially, if a business is more valuable if closed and its component parts sold, then why would any rational owner continue to operate the business?

The cost approach is a useful sense-check to see if any assumptions when using the income approach or market approach are wrong.  Furthermore, if one party in a dispute is insistent on using the cost approach, but there are no indications that the business won’t cease trading, then this could be indicative of an attempt to artificially depress the value of an asset.

In a matrimonial context, the cost approach can be useful if one party considers that their contribution to a business is such that their walking away from the business renders it non-viable as a continuing entity.

How we can assist

At Sedulo Forensic Accountants we have experience in valuing businesses and assets in a matrimonial context and can assist with:

  • Valuing assets for the purpose of a financial settlement;
  • Acting as a Single Joint Expert to determine the value of any marital assets; and
  • Acting as a party-appointed expert for the purpose of contentious valuations.

Contact

Mark Strafford, Head of Civil Forensic Accounting

mark.strafford@seduloforensic.co.uk