When Co-Owners Call it Quits: The Case For Expert Valuation and Mediation in Business Divorce

Like a marriage, business relationships between partners or principals can come to an unexpected end. When no pre-existing agreement about partnership dissolution exists, issues like retirement, financial successes or reversals, or disputes between co-owners can force a business dissolution or business divorce. Not only is a business divorce often contentious, long, and expensive, it can also cause disruption and risk to the enterprise.

For businesses without pre-existing agreements about business divorce, valuation and mediation are effective ways to achieve business divorce. Valuation helps to ascertain a full and fair value of the business. Mediation is a confidential and non-confrontational way to achieve a fair basis for the separation.

In this article, Gavin/ Solmonese experts answer frequently asked questions about valuation, mediation, and business divorce. The experts include:

• Frank A. Monaco, Jr., Esq.–Managing Director, Mediation & ADR Services
• Anne Eberhardt, CFE, CAMS–Senior Director, Valuation & Litigation Consulting
• David Benick, ASA–Senior Director, Valuation & Litigation Consulting
• Pamela O’Neill — Managing Director, Valuation & Litigation Consulting (not present for photo)

For a dispute as difficult as a business divorce, why are valuation and mediation so valuable?

Without the benefit of a pre-existing agreement, business divorce can be protracted, expensive, and emotionally draining and can adversely affect a healthy business. Valuation by a skilled, independent business appraiser will help provide a credible value of the company, including the worth of certain assets and potential future earnings. Mediation can be a relatively inexpensive way to bring certainty to the process and preserve value for both parties without the expense associated with protracted litigation.

What milestones should be reached before all parties sit down to mediation?

Before the first mediation session, it is important that the parties are armed with all relevant information and understand each side’s position. In addition, it is also important that an appraiser with business valuation expertise determine the value of the business and the relative interests of the principals involved in the business divorce. Once those criteria are met, mediation can be used to craft a creative solution that may involve a liquidation of the business; a sale of the entire business as a going concern to a third party; or the sale of one principal’s interest in the entity to another principal or a third party.

Is it really necessary to use a professional business valuation expert?

A professional business valuation expert brings a wealth of experience to what is typically a complex process. The professional appraiser considers all business valuation methods in the initial review of a case in order to effectively analyze the business from all appropriate angles, including current and projected financial performance, economic environments, industry sector, and more. The choice of valuation methods, and the appraiser’s experience in applying those methods, can make the difference in a final report that can stand up to close scrutiny.

Business valuation can be a touchy subject. What have you observed in reviewing many appraisals for business divorce?

In developing the equity cost of capital for a discount rate calculation, some appraisers add a company-specific risk adjustment (CSRA) to present value cash flows. This adjustment is an area where mistakes can happen, simply because the CSRA represents the appraiser’s educated, best guess of an appropriate return. Adding a CSRA is subjective, and at Gavin/Solmonese, we are diligent in assessing a company’s risks, including whether the CRSA is valid. In certain matters, we have observed that an opposing expert’s justification for the CSRA was not substantiated or was incorrect. For example, we go the extra step and research market evidence, such as information included within the management discussion letter to the annual reports of the comparable companies. The data provided by these disclosures often conflicts with an opposing expert’s claims that certain risks need to be addressed. Typically, we find that these risks are already reflected in an industry factor or size factor in the discount rate calculation, and introducing a CSRA is duplicative to the analysis, thereby increasing the discount rate and decreasing the valuation. Thus, the fact that we review the annual reports and perform greater due diligence than the opposing expert increases the credibility of our valuation analysis.

How can parties in a business divorce choose a valuation expert and a mediator who will be a good fit?

There are both professional criteria and personal criteria to consider when choosing a valuation expert and a mediator. The valuation expert should be able to demonstrate an understanding of multiple valuation methods and formulas; have expertise in valuing companies in the business sector that applies to the case; and have a track record that illustrates capability in managing the complexities of business valuation.

The mediator should have a solid understanding and experience in the type of business dispute in the particular case and have a solid reputation backed by professional training. In addition, the mediator should have a reputation for patience, persistence, and listening, and be able to correctly evaluate situations and understand human motivation. It also helps if the mediator has a good sense of humor.