Double Dipping in Divorce Valuations
One key component of valuing a business involves normalizing (adjusting) financials to reflect the earnings associated with the business’s operations. This often entails removing fringe benefits and perks as well as adjusting for a normalized Shareholder salary that would be required for an owner/manager to perform the tasks of said Shareholder.
What is Double Dipping?
Double dipping within a valuation utilized for divorce proceedings is the concept in which the same income stream is counted twice, first in the property division and again in the alimony determination. A company’s earnings stream is most often used to value an owner’s interest and, in turn, determine the equitable distribution of property.
The Shareholder’s alimony obligation will be based, in part, on their income received from the business. If the company’s profits are considered as part of the owner’s total income for support purposes, then that income utilized to value the business for the property division is being used a second time.
The Impact of Utilizing Adjusted Salary within Determination Calculations
Shareholder salary and company earnings are directly related; if a Shareholder takes a higher salary, it decreases the company’s earnings. Conversely, if the Shareholder receives a salary below market value, the company’s earnings/profitability appears to improve.
Take this very simplistic example of ABC Company:
Company Revenue | $2,000,000 |
Cost of Sales | $1,000,000 |
Overhead Expense | $750,000 |
Shareholder Salary | $250,000 |
Net Income | $0 |
In utilizing a normalized salary of $100,000, the Net Income increases from a breakeven of $0 to having a $150,000 profit:
Company Revenue | $2,000,000 |
Cost of Sales | $1,000,000 |
Overhead Expense | $750,000 |
Shareholder Salary | $100,000 |
Net Income | $150,000 |
The Shareholder’s spouse would be entitled to 50% of the property, or $75,000 ($150,000 X 50%).
The alimony determination utilizing 50% of the total Shareholder salary received ($250,000) is $125,000.
Based on the above, the Shareholder’s spouse will receive $200,000 ($75,000 + $125,000) and the Shareholder retains $50,000 ($250,000 – $75,000 – $125,000).
If this were adjusted for “double-dipping”, then the alimony payment would be based on the adjusted shareholder income, or 50% of $100,000. The Shareholder’s spouse would now receive a total of $125,000 ($75,000 + $50,000) and the Shareholder would retain $125,000 ($250,000 – $75,000 – $50,000). Summary below:
Shareholder Retains | Spouse Receives | |
Based on Actual Salary | $50,000 | $200,000 |
Based on Adjusted Salary | $125,000 | $125,000 |
Difference | $75,000 | $(75,000) |
Take Away
Earnings metrics are the basis of most valuation methodologies. Valuation adjustments, especially regarding larger ticket items such as Shareholder compensation, therefore significantly impact the conclusion of value. The court’s opinion on this issue differs from state to state. It is best to consult your legal counsel regarding how to approach double dipping in a specific divorce scenario.
Divorce Valuations Summed Up:
Suppose you need to know the actual value of something, such as for a sale, buy-sell agreement, acquisition, or divorce. In that case, it is recommended that you have an actual valuation conducted by a qualified professional. While estimates can be helpful in informal scenarios, a certified valuation is necessary for legal and formal purposes.
Since 2003, Quantive has performed over 3,000 business valuations. Contact our valuation specialists for a no-cost consultation today.
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