Valuation Date Requirements under the Family Law Act – Part One

February 14, 2018

Share on:

The value of a business is expressed at a point in time. Depending on the nature of the business, its value can change significantly over time. Therefore, the selection of an appropriate valuation date can have a substantial impact on the financial terms of a settlement involving the division of family property.

Part one of this two-part blog series examines the general rule that governs the selection of a valuation date and how valuators might consider adjusting their conclusions to be in strict compliance with the Family Law Act (FLA).

The General Rule

Section 87 of the FLA requires, unless an agreement or order provides otherwise, that the value of family property be based on fair market value at the date of trial.

“Unless an agreement or order provides otherwise and except in relation to a division of family property under Part 6,

a. the value of family property must be based on its fair market value, and
b. the value of family property and family debt must be determined as of the date

  1. an agreement dividing the family property and family debt is made, or
  2. of the hearing before the court respecting the division of property and family debt.”

Practical Issues that make Compliance Difficult

Valuators are frequently retained to prepare their valuation “as at a current date”. However, the date of their appointment can be several months before the actual trial is scheduled to commence. Therefore, even in the best-case scenario where up-to-date financial information is available, the valuation conclusions will not reflect any change in value between the date of appointment and the trial date. We all know that, in the world of commerce, a lot can change in several months.

For practical purposes, the effective valuation date is usually the date of the most recent financial statements. So, in the worst-case scenario, where the most recent financial statements available are already twelve months old (or more), the situation is made worse. For example, if the most recent financial statements are dated twelve months ago, and the trial date is six months after the date of appointment, we could be talking about a year and a half time lag between the effective valuation date and the trial date. This would certainly not be fair to at least one of the parties in the dispute, and would certainly not be in compliance with the requirements of Section 87.

Suggested Methodology to Correct a Stale Dated Valuation

Valuators might consider using the following methodology to determine an appropriate adjustment to restate their valuation conclusion as of the trial date[1].

The valuation of an operating business is usually based on the Income Approach, and more often than not, by applying the Capitalized Cash Flow (CCF) method. One of the key inputs to this methodology is the determination of a maintainable level of “discretionary cash flow”. This is often based on the following analysis:

  1. Normalization of the company’s historical earnings (usually expressed as EBITDA[2])
  2. Examination of the trends in normalized EBITDA and consideration of management’s expectations about the future and, if appropriate, consideration of the industry and economic environment
  3. Selection of a range of “maintainable EBITDA” (based on the above)
  4. Deduction of income taxes and any required capital reinvestments to sustain the business, to determine discretionary cash flow

Discretionary cash flow is capitalized using an appropriate rate of return that reflects a number of assessments made about the business[3]. The result provides the basis for an estimate of business enterprise value (BEV), from which the company’s equity value is derived[4].

By capitalizing discretionary cash flow this way, the valuator has inherently assumed that the estimated amount of discretionary cash flow will continue in perpetuity. If this assumption is reasonable, then it should also provide a reasonable basis for estimating the additional value created by the business subsequent to the initial valuation date.

Consider the following example:

  • A valuator was retained on December 31, 2017 to provide a valuation as of a current date
  • The most recent financial statements available are dated December 31, 2016 (the effective valuation date)
  • The trial date is scheduled for June 30, 2018
  • The valuator determines the business had a value of $1 million by capitalizing discretionary cash flow of $200,00 using a 20% capitalization rate ($200,000 divided by .2)

The valuator could then adjust the value of the business to a “trial date value” by adding one and a half years of discretionary cash flow (i.e. $200,000 x 1.5) to the valuation as of December 31, 2016. This would give the valuator a total of $1.3 million.

In doing so, the valuator might also consider making the following enquiries to confirm that no other adjustments are necessary:

  • Have there been any changes in the business fundamentals that would suggest the previously estimated maintainable EBITDA is no longer valid (examples include the loss of a key customer, the release of a new product or service, etc.)?
  • Have there been any distributions outside the ordinary course of business (e.g. dividends or salaries paid above the market level of compensation[5])?
  • Have any new shares been issued or existing shares redeemed?
  • Have any new liabilities materialized that did not also result in an offsetting asset of equivalent value (examples would include a tax reassessment or an award pursuant to a law suit)?
  • Have there been any changes in asset values beyond the ordinary course of business (examples might include unusual bad debts, uninsured losses or changes in the market value of redundant assets such as investments)?

It is important to note that a change in the level of debt would not necessarily require an adjustment to the value determined at an earlier date. For example, any reduction in debt would usually have an offsetting cash outflow associated with it (unless the debt was forgiven), and vice versa.

This article provides an overview of how a valuator can update his valuation conclusion in order to comply with the requirement of Section 87 of the FLA to value family property as of the trial date. However, it remains the obligation of counsel to request such an update!

Stay tuned for part two of this series where we review special situations in which a variation from the general rule regarding valuation dates might be warranted, with examples from actual case decisions.

If you would like more advice on this topic, please contact one of our trusted Chartered Business Valuators.

[1] The adjustment could be provided by way of an addendum attached to the original report. It does not depend on the availability of current financial statements as of the trial date.

[2] Earnings before Interest, Taxes, Depreciation and Amortization (a measure of the pre-tax cash flow generated by the business that is available to equity and debt security holders)

[3] These include assessments about relative risk, growth opportunities, the type of capital structure that could be used to finance the business, and others.

[4] For example, BEV plus redundant assets, minus net debt (and other non-business liabilities) equals Equity Value.

[5] Based on the assumptions applied in the process of normalizing historical earnings.

Ask Us a Question

Sign up to receive our newsletter