In a divorce case involving a privately held business, two valuation experts review the same company. One concludes it’s worth $3 million. The other arrives at $4.2 million. The natural reaction is to focus on the $1.2 million difference. But what if the majority of that difference comes down to just one or two assumptions?
Divorce is emotional, and clients often have strong feelings about how the business was operated during the marriage. Disagreements over past financial decisions, spending habits, or how one spouse managed the business can become significant points of contention. While those concerns deserve consideration, they can also make it difficult to separate the broader disagreements between the spouses from the specific assumptions driving the difference in value. For attorneys working toward a settlement, identifying those assumptions can help narrow the discussion and create opportunities to work through the differences one issue at a time.
What’s Driving the Difference?
Consider a hypothetical construction company. Both experts review the same financial statements, yet their conclusions differ substantially. A significant difference in value can sometimes be traced to something as specific as how the experts treated a single assumption. Consider the following examples:
• Representative revenue. One expert believes the company’s recent revenue growth is sustainable. The other places greater weight on historical performance, resulting in a lower revenue expectation.
• Owner compensation. One expert believes the owner is overcompensated by $75,000 annually. The other considers the compensation reasonable.
• Personal expenses. One expert identifies $50,000 in personal expenses paid through the business and adds them back to earnings. The other determines that only $20,000 represents an appropriate adjustment.
Each involves professional judgment, and both experts may have supportable positions. Any one of these assumptions could have a substantial impact on value. The difference between two reports may involve several assumptions, but one or two could account for the majority of the difference in value.
Start by Isolating the Assumptions
The first step is to ask your expert to break down the difference between the two conclusions. Rather than comparing the reports as a whole, identify the specific assumptions where the experts differ and quantify the impact of each. For example, how much of the $1.2 million difference is attributable to representative revenue? How much relates to owner compensation? How much is driven by the treatment of personal expenses? Or something else?
This may require your expert to recalculate their valuation using selected assumptions from the opposing report. The goal is to understand how much each assumption contributes to the difference. Keep in mind that valuation inputs can interact, so the individual differences won’t always add neatly to the total gap. Still, the exercise helps identify which issues deserve the most attention.
Evaluate the Support Behind Each Position
Once the significant differences are identified, work through the assumptions individually.
Representative revenue. If one expert relies more heavily on recent revenue growth while the other uses a longer historical period, understand why. Has the company gained or lost major customers? Were recent results influenced by unusual events? Has the business made changes that would explain a sustained increase or decrease in revenue?
The discussion should focus on which revenue assumptions are best supported by the company’s operations and outlook.
Owner compensation. If the experts disagree about the appropriate adjustment, examine the information supporting each position. What responsibilities does the owner perform? What would it cost to replace them?
Perhaps one expert has information the other hasn’t considered. Maybe further review supports an adjustment somewhere between their original positions. Or perhaps one conclusion is better supported.
Personal expenses. When experts disagree about expenses paid through the business, start with the underlying transactions. What expenses have been identified? Is there documentation showing they were personal rather than business-related? Were those expenses actually recorded on the income statement, or were they already accounted for as distributions to the owner?
This distinction can be particularly important in divorce cases. One spouse may know that personal expenses were paid through the business and assume those amounts should be added back to earnings. But if the expenses were ultimately recorded as owner distributions, they may have already been excluded from business expenses. Adding them back again would overstate earnings.
Other expenses may be partially personal and partially business-related. Reviewing the transactions and how they were recorded can help determine whether an adjustment is appropriate and avoid counting the same amounts twice.
Test Potential Compromises on Individual Assumptions
After understanding the support behind each expert’s position, there may still be areas where both experts have reasonable arguments and the parties remain divided. This is where attorneys can take a different approach to settlement. Rather than splitting the difference between the two overall valuations, consider what happens if the parties compromise on a specific assumption.
For example, one expert believes the company’s representative annual revenue is $5 million, while the other supports $5.5 million. Both have sound reasoning for their conclusions, but neither party is willing to accept the other’s position. What if the parties considered $5.25 million in representative revenue for settlement purposes?
Ask your expert to calculate what the business would be worth using that revenue assumption, including the resulting impact on earnings. The expert’s original opinion remains unchanged, but counsel now has an additional scenario to consider.
The same exercise can be applied to owner compensation, personal expenses, or any other underlying assumption. Perhaps the parties agree to use a compensation adjustment between the two experts’ conclusions, or concede a portion of the disputed personal expenses.
The advantage is that the parties can be selective in where they compromise. They may be willing to concede on one assumption while holding firm on others. And because the financial impact of each assumption has been quantified, they can understand what those concessions mean for the overall value. This gives attorneys a way to negotiate specific issues based on the strength of the arguments and the willingness of the parties to compromise.
Building a Settlement Strategy
A difference in value can seem difficult to overcome when initial reactions are centered on the gap in final numbers. But once the underlying assumptions are quantified, the path toward settlement is likely to become more manageable. Not every disagreement needs to be resolved, and not every assumption requires a compromise. The opportunity is to identify where the parties have room to move and use those individual decisions to work toward a resolution.
A million-dollar difference doesn’t always require a million-dollar compromise.
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