Business divorce can arise in any privately owned business, often without warning. These can be divisive, long-lasting and expensive—straining both stakeholders and the business.
The business valuator must carefully scrutinize the characteristics in the interest being valued to determine stakeholder equity. This includes reviewing business information and assessing equity risk in order to produce a value conclusion addressing those risk factors.
Discounts may apply in some situations. Valuation discounts are essentially the difference between fair value and fair market value. Discount applicability in a business divorce matters varies by state and alleged action.
The two main discounts considered in a business divorce engagement are a (1) discount for lack of control (DLOC); and (2) discount for lack of marketability (DLOM).
A DLOC is a reduction in an entity’s equity interest value due to a stakeholder’s lack of ability to exercise control. The value of an equity interest for a stakeholder in a minority position should have less monetary value than one with majority control.
A DLOC considers the benefits of control not available to a stakeholder’s minority equity ownership position and generally includes the ability to:
- Change or appoint management.
- Change the bylaws and articles of incorporation.
- Influence and control the board.
- Control management compensation.
- Sell, recapitalize or liquidate the company.
- Declare/pay shareholder dividends.
- Lease, liquidate or acquire business assets.
- Influence the company’s course of business.
- Sell the entity.
A DLOM is a reduction in an entity’s equity interest value due to a stakeholders’ inability to convert or sell their interest quickly and with amount certainty. When quantifying a DLOM, the business valuator must understand the impact of these company characteristics:
- If the equity interest is private or publicly owned.
- Financial condition per the financial statements.
- Dividend-paying policy and history.
- Nature of the company, its history, industry position and economic outlook.
- Control implicit in interest to be transferred.
- Management depth and quality.
- Restrictions on interest transferability.
- Interest holding period.
- IPO costs.
For both DLOCs and DLOMs, business valuators use various empirical studies to support the discounts chosen. Ultimately, business valuations are an estimate of value at point in time. They are based on information provided by both parties along with external and market sources. Therefore, if you choose not to retain a qualified professional to help with the business valuation process, you do so at your own peril.