COVID-19 - The Impact of Coronavirus on Family Law Property Settlements
In a number of recent Family Law matters where I have been involved, the impact of the current economic situation, brought about by the coronavirus pandemic, has been considered.
In one, a party asserted that the value of a business they would retain post settlement had been severely reduced, in line with the decline in profitability of the business.
In principle, the argument was valid, but only to a certain point. Sometimes the business valuer adopts an earnings based approach to the valuation. That involves converting the ongoing level of earnings into a capital value. In other instances, the valuer may conclude that an assets based approach is more applicable. Usually, the final for business value is the higher of the amount determined using the earnings or assets based approaches.
This means that if business’ earnings decline, the value determined on an earnings basis also declines. In those instances, the final concluded value may decline, but only to the level which would be determined by the assets based approach.
By way of example, suppose a business rented out garden tools on a daily basis. Assume also it had assets which could be sold for $500,000 and profit after adjustments, including working proprietor remuneration was $150,000. A hypothetical business valuer adopted a capitalisation rate of 25% and concluded that the business is worth $600,000. They compare this to the value of assets ($500,000); determine that $100,000 goodwill (difference between total value and operating assets) is reasonable and so are content with their assessment.
If the impact of coronavirus on this business was a decline in the adjusted profit to $50,000, would this mean that the revised concluded value would be $200,000? Under the earnings based approach, it could be even lower than that if the valuer determined that the risk associated with the business had increased. If they thought that the appropriate capitalisation rate now should be 30%, that would suggest a value of $150,000 using an earnings based approach.
In this situation, the business valuer would revisit the assets based approach. Assume for this illustration that the market for second hand garden tools was fairly solid and that the assets of this business were still worth $500,000. The business valuer’s likely conclusion is that the business is now appropriately determined using an assets based approach and is $500,000.
Another matter involved a fairly unique business. Suffice to say that the customers of this business have access to money which is not impacted by the current economic situation. Further, the operation of the law requires specified entities to acquire services of the type provided by this business. These factors are unique and they combine to mean that the impact of coronavirus on this business’ value is somewhere between negligible and insignificant.
The unique features of this business illustrate why the valuer needs a full understanding of how a business works and does not confine their valuation considerations to historical financial reports.
Another likely major impact on Family Law property settlements could well be the ability of parties to borrow money to fund settlements.
The effect on property prices, typically used as security for borrowings, is uncertain, and a decline in some sectors would not be surprising. On the other hand, there may be strong demand and therefore solid value for some types of property. It would make sense that the value of a commercial property with a Commonwealth Government or a major supermarket tenant would be stable or even increase.
Clearly, a decline in business profitability or a loss of employment impacts on a borrower’s capacity to service borrowings. The financial institutions’ assessment of the permanence of this is likely to influence the level of borrowing which can be obtained.
It is too early to see how lenders will respond. Increased creativity for the structure of some settlements may be needed.
Daniel Rands is a Forensic Accounting Specialist, as awarded by Chartered Accountants Australian New Zealand, and practices extensively in Family Law matters supporting legal teams with business valuation, settlement structuring and associated taxation advice.