During a divorce, spouses will need to consider dividing family property and making an equalization payment. Some categories of property will be easy to deal with, but others, such as an ownership interest in a business, can be more challenging and raise valuation issues. Spouses can have different ideas about what a business is worth. Often parties will hire a valuator to make an assessment. However, there are different valuation methods, and the parties can still disagree about the assumptions used in reaching a valuation. These issues are compounded when the business is new and there is not a lot of financial documentation to rely on.

Some Evidence is Inadmissible to Establish the Value of a Business

In Debora v. Debora, the court explained that valuation is more of an art than a science, and that mathematical certainty is not possible. Additionally, the choice of the valuation method can depend on the nature of the business. These issues were relevant in Khaira v. Ghumman, which dealt with a dispute over the valuation of the respondent’s business interest. On the date of separation, the respondent had a 50% interest in two orthodontic practices. The parties both retained business valuators to provide an opinion on the value of the respondent’s corporations, although they arrived at different valuations of the enterprise value of the corporations.

Additionally, in 2018, two years after the valuation date, the respondent purchased the remaining 50% in the corporations for $1,540,889. The applicant pointed out this was the same 50% interest analyzed by the valuators and could be used to cast doubt on the reasonableness of the husband’s valuator, who had suggested the corporations had zero equity on the valuation date.

Evidence Used to Test the Reasonableness of Assumptions Used by Valuators

The respondent objected to the use of the 2018 transaction as evidence claiming that it was “hindsight evidence” and was inadmissible. In Debora, the court looked at a statement in Woeller v. Woeller, which suggested that evaluating the fair market value of a business through hindsight evidence is inappropriate, but “one cannot entirely ignore events” following the valuation date “in assessing the fundamental assumptions underpinning the opinions expressed” by the experts. On that basis, in Debora, the court concluded that the actual results were inadmissible to establish the value of the corporation on the valuation date, but it could be used to test the assumptions the business valuators used.

In Khaira, the respondent’s view was that the judge should find his 50% interest in the corporations had no value on the valuation date and also ignore the fact that he paid $1,540,889 for the same 50% interest two years later. However, the court disagreed. While the corporations had to be valued based on the knowledge available at the valuation date, the 2018 transaction could be used as evidence to test the reasonableness of the assumptions that the valuators used. Ultimately, in this case, the judge found some of the analysis by the respondent’s expert was not reasonable and led the judge to accept the alternate valuation by the applicant’s valuator.

Pre-Incorporation Company Not Included in Net Family Property

In Jain v. Jain the applicant claimed that the value of a start-up business the respondent controlled should be included in the respondent’s net family property, as he developed the business plan during the marriage. She claimed that since an investor spent USD $350,000.00 for an 8% equity stake in the company, the company should be valued at over $3,000,000.

The respondent, in turn, argued that the company did not exist at the time of the separation, and since it had no revenue, it was incapable of valuation. For the judge, it was problematic bringing the respondent’s 92% controlling interest in the company into his net family property calculation as the company’s incorporation occurred after separation. The question was, if there was a value that could be given to the pre-incorporation business, and if the business was developed during the marriage, could it be included in equalization? The court concluded that was no more than a theory in this case, as without any evidence that pre-incorporation the company had value, the respondent’s 92% interest could not be included in the equalization calculation.

Lack of Financial Data Complicates Valuation

The respondent’s business was also relevant to the calculation of his income. On this issue, however, the income that could be imputed to the respondent did not depend on the incorporation date being before or after the parties’ separation. The applicant retained an income valuator to provide an opinion on the amount of income that should be attributed to the respondent. The valuator indicated that a shareholder loan of nearly $44,000.00 that the respondent received from one of the corporations he controlled should be counted as income. This was added to the figure of $28,000.00 the respondent reported to the Canada Revenue Agency (CRA). Finally, the valuator analyzed corporate financial statements and concluded $32,000 that was charged to the corporation could be imputed as personal expenses. This left the possibility of attributing income of $104,000.00. However, the Court was concerned that there was only a short interval of financial data to make the assessment.

The respondent hoped that the business would have a positive cash flow within several months. However, as the judge noted, the evidence of the respondent’s income earning capacity and his actual earnings appeared as an assortment of numbers. While it was possible to conclude that his personal and corporate income combined for a total of $104,000.00 in 2020, there was no indication the economic conditions were such that he would be able to replicate that in the future. Similarly, the judge concluded that the business venture had “no measurable value at the present time, or even a reliable present value of future income or capitalization”. Yet, the respondent did have some source of income.

Court Acknowledges Wide Gap Between Realistic and Optimistic Business Valuation

The challenge was that there was a wide gap between “a realistic valuation of the business as currently worthless and an optimistic valuation of it as modestly limitless”. The judge found that it was unreasonable to impute the value of the respondent’s annual income as low as $30,000.00 or as much as $104,000.00. While the respondent accepted a figure of $40,000.00, this was not determinative either.

As the judge explained, the court’s job is not to reach a bargain or impose an amount given the parties’ stated positions. The fairest result appeared to be the midpoint between what the respondent reported to the CRA and the amount the valuator measured as combined corporate and personal income. Significantly, section 17(1) of the Child Support Guidelines permits courts to determine an amount of income that is fair and reasonable in light of fluctuation or a pattern of income over the prior three years. That was relevant here where the respondent’s income lacked consistency. Accordingly, the court imputed an income of $55,000.00 to the respondent.

Set Realistic Expectations Regarding Valuations

Equalization requires that the value of assets owned by the spouses be determined at the time of separation. However, courts agree that valuation is not an exact science and that different approaches can be used. When there are conflicting valuations, courts will choose values that appear fair given the context. Parties also need to have realistic expectations of a business’s potential when thinking about how a business should be valued.

Contact NULaw in Toronto for Trusted Advice on Business Valuations and Assets Protection Upon Separation and Divorce

At NULaw, our experienced team of family law lawyers have years of experience guiding business owners and entrepreneurs through changes in their personal lives. We work closely with each client to understand their circumstances in order to provide them with legal advice regarding their rights and responsibilities upon separation or divorce. We strive to fully understand the nature of your venture, protect your assets, and safeguard your financial future as your situation evolves. Contact us online or at 416-481-5604 to book a confidential consultation.