Hamilton Law Association January 2010

January 2010

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Family Law Calculations for Business Owners and the Self- Employed

Bruce R. Horsley HBA CA•IFA CFE ACFI CBV

Horsley & Associates Inc.Phone (905) 528-4446

www.hacbv.com

Self-Employed is Becoming More Common

• A Statistics Canada 2010 study concluded that by 2009 about 16% of the workforce is self-employed

• Self-employment is growing

• – between Oct 2008 and Oct 2009 self employed increased 4.18%

• – Private sector workers declined 4.1%

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Divorce Forensic Accounting is Unique

• Growth of small business• Type A business owners – aggressive • Managing spouse – assumed role handles money,

decisions, knowledge• Lack of knowledge one spouse• Interview non business spouse

– It is amazing what they have been told about the cheating


• Divorce – Even when Amicable – Division of property/income for support – not amicable

• Judge/lawyers need all the facts

• Breadwinner – feel entitled to more because breadwinner

• Parties become deceitful and selfish



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• Problems of Unfair Information Advantage

• Creates Need for Forensic Accounting for Divorce Engagements – see training book, training courses, joining professional associations.



• Previous base data subject to tax avoidance accounting

• Emotions create hurt – feelings, basis to justify, dishonesty for fairness reasons

• 3rd Parties not normally involved may assist in concealment


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• Normal law abiding citizen’s emotions cause justification for evening the scales

• Now add Type A person aggressive behavior of business owner

• In a business sale there is mutual interest to obtain a deal and therefore information is available in order to complete the transaction. Due Diligence is equivalent to Divorce Forensic Accounting


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Divorce Forensic Accounting Procedures

• Use Common Forensic Analysis procedures

• Change in Net Assets Test

• Personal Lifestyles Analysis

• Other costs – new friend (significant other) – Emotional response to benefits new friend receives



• Personal lifestyles analysis

• Taxes on house equal to salary

• Has 50k salary owns $1.5 million house

• Estimate Cost of Lifestyle

• Look at who paid for benefits received

• Secret business ownership

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• Very expensive

• Use Step Approach- Do this and then report back

• Most Type A business owners – Refuse to provide obvious guilty documents

• Computer accounting systems– Data searches



• For Controlling Costs– Use Step Approach – Perform These steps for $xx

and report back to determine next step

– Use Cost Benefit Analysis ( Utilize ½ after tax benefit received)

• Sometimes (Often) the Results of Forensic Analysis Causes the File to Settle or Request for Specific Data Causes the File to Settle


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• Most CBV’s have been trained in the new rules for Civil Procedures

• For Many CBV’s new rules are just old common sense



• Do Not Expect Business Owners Litigation Accountant to Perform Forensic Procedures on his own data unless Lawyer Pushes for Some Procedures- (Very Good Idea)

• A Large Benefit of a Joint Assignment is Access to Information


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• Other data sources:– Ex employees

– Ex girl friends

– Ex accountants

– Your client did it to first wife

– Ex children (have chosen sides)


Divorce Forensic Accountants Associations

• Need training in Forensics• People don’t know what they don’t know • Professional Associations

– Chartered accountants – IFA forensic CA specialist– CFE – Association of Certified Fraud Examiners– ACFI – Association of Certified Forensic Investigators

(Canada)


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Common Calculations for Business Owners

• Net family property

• Fair Value – Date of Marriage (cohabitation)

• Fair Value – Date of Separation

• Income For Support

• Other Business Accounting Balances



• Other Business Accounting Balances– Management bonus payable – DOM, DOS– Accrued vacation pay – DOM, DOS– Shareholder loan/advance – DOM DOS – Expense account payable– Personal Assets in Business (Boat) – NFP correction– Wages payable– Un-entered expenses receivable– Visa reimbursement receivable


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– When did financial cheating accelerate

– Tax avoidance - Common Great Canadian Game

– What are Fair changes to circumstances ie– lost customer



• Business Financial Statements Often – Notice to Reader Report by Accountant

• Audits, reviews for financial statements not designed divorce calculations

• CRA – has the power to audit• Banks – send in investigator for look /see report – 25k

• Banks – industry data– Very knowledgeable

• Sometimes only lend against specific assets– No reliance on financial statements


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• Litigation Accountants– Knowledgeable about Family Law

– Knowledgeable about Industry, Business

– Naturally Skeptic

– Take Time to Think

– CBV need separate training in Forensics



Canadian Institute of Chartered Business Valuators

• Recognized professional association of 1,200 Chartered Business Valuators- recognized CA specialist program

• Designation requires training, experience, exams

• Rules of professional conduct

• Published reporting standards

• File standards

• Work standards

• Recognized by Courts for Objectivity, Credibility

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Chartered Business Valuators

• Many are very knowledgeable About– Family Law Valuation Principles

– Income For Support Family Law Principles

– Have Read Child Support Guidelines

– Have Read Money & Family Law

– Have Read Financial Principles of Family Law



Which Financial Expert To Use?

Litigation Accountant/CBV•Knows industry, similar business•Independent/objective credible on file•Technically competent:

– Valuation expert– Forensic analysis– Taxation– Knowledgeable about Family Law and

progression of file– Knowledge of rules of litigation

• Assist throughout file:– Disclosure, discovery, motions,

settlement conferences at trial•Relied Upon At Pretrial Conference•Qualify as expert witness

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In Certain Circumstances Jointly Retained Financial Experts Is A Good Idea In Other

Cases It Will Not Work

Save costs by sharing costs – maybe 60% joint costs

Better access to information – especially in forensic

situations

Time to resolve the dispute can be less

Greater sense that the process is fair

Income for Support Analysis

• Normal 4 General Personal Tax Return Business Rules – Often Exaggerated Responses

– Meals- 50% allowed- Was it a business meal

– Auto Mileage kilometer Allowance or % Business Use

– Home Office

– Convention Expense (or vacation)


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• Need Lifestyle Analysis– How was that (x) paid for

– Business expenses on Saturday/Sunday

– There is huge ever changing list of how people cheat on taxes (unless adjusted for includes effect on spouse)

– Does Income Analysis match Lifestyle (Golf Club)



• Effect of Recession- discloses hidden assets

• Delayed Business Opportunities– Creative Accounting To Avoid Good News

– There are many ways to cheat

– Normally do not tell your Chartered Accountant Where you are Cheating

– If Accountant does not Belong to Professional Association There are No Rules Requiring Them to be Honest


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Business Valuation Analysis• Report types

– Calculation Report – little review, no industry analysis- very low credibility

– Estimate Report – limited industry/economic analysis – reasonable credibility

– Comprehensive Report – most detailed analysishighest credibility

Factors such as business value worth $25,000 calculation report whereas $1 million comprehensive report – depends on circumstances.



Comprehensive Review and Analysis of Business, Industry

• Company Background• Marketing

• Management• Employees and Industrial Relations

• Manufacturing, Distribution• Management Information Systems• Financial Analysis, Ratios, Graphs

• Finances• Economics

• Industry• Comparison to Competitors

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Business Valuation Analysis• Report types –

– Limited Critique Report – Comments on analysis of someone else’s report- limited usefulness

– For a Limited Critique Report to have a conclusion it becomes an Estimate report

– Rebuttal Report- is not covered specifically by standards usually an addendum to a Comprehensive Report


Business Valuation Analysis• Different levels of credibility of analysis usually

depend on level of scope of review, analysis of procedures performed and industry/ economics research

• A comprehensive report may not be possible due to data limitation on financial statement quality and accountants report

• Check CICBV.ca website for detailed standards

• The Standards have been changing yearly so need current rules.

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Accuracy of The DataDiscretionary Management Actions

• Did owner of business realize his affair could end his marriage and therefore changed

• They saw you coming two years ago!!!!• Dressed down/up operating results• Increase in marketing costs• Increased other expenses• Spent time on other matters rather than working

in business- decreases income• Excessive bad debt allowance


Unique Problems of SOHO Business Valuations

• Business reliance on one/two people– Personal goodwill/knowledge of business

• Uniqueness of business

• Cash based business- unreported income

• Cost benefit analysis to value business

• Anticipated effects of new technology

• Accounting records often poor• usually prepared solely to minimize income tax expense

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Business Valuation Analysis

• Why not hire a CBV to Mediate/Arbitrate Differences in business value



• What are acceptable scope limitations and when do you need a motion to get more information- judgment

• What happens when 1 side hires a new CBV (what does it mean

– the prior CBV found something he won’t ignore or there were client relations problems or they really disagreed with the answer)


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• Google industry research

• Web research

• There are Research Services such as First Research

• Industry analysis are important


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• For Family Law – value is not defined

• Do not assume CBV’s standard Fair Market Value is always appropriate

• The intended result is fair value – often means a fair and equitable settlement between spouses in the circumstances



• Often date of marriage data

Is very hard to locate and estimates are used

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• When planning a file

• A CBV can provide verbal planning number often a range which can be used to decide on how much effort/money to spend on this one family asset.

• The costs of disposition can include professional fees and income tax costs and are often present valued from likely date of sale back to date of separation



• Significant Judgmental Areas:– Estimate of future earnings/cash flow

– Capitalization multiple used (cost of capital)

– Valuation method used

– Effect of unreported cash sales

– Left out normalization adjustments

– What is fair business owner remuneration for efforts extended or results achieved


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Significant Judgmental Areas ( Continued):– Selection of amount of external finances

– Looking for delayed sales or accounts receivable, bad debts, inventory not counted at date of separation financial statements

– Selection of minority discounts

– Transactions with friends/related parties



• Common methods for business valuations:– Capitalized Earnings

– Capitalized Cash Flows

– Discounted Cash Flows

– Adjusted Book Value

– Sellers Discretionary Earnings

– Gross Revenue Approaches

– Other Rules of Thumb – multiple of EBIT-DA

PLUS - Non-business Assets/Liabilities Redundant Assets


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There are many unique methods/adjustments due to nature of business

• Tim Horton's– present value lease benefits

• Construction company adjusted book value & percentage of profit backlog

• Insurance brokerage – multiple of enforce revenue– discounted cash flow analysis



• Books on how to adapt valuation methodology to certain business types are growing with new information yearly.


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• Goodwill/Intangible Asset Value

• Personal Goodwill vs. Commercial Goodwill

– Personal Goodwill:• i.e. personality, ability• not transferable• does not form part of fair market value or fair value

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Commercial Goodwill is transferable• Individual goodwill i.e. customer

knowledge replaceable equally capable person

• Location goodwill – Tim Horton's • Service goodwill – service acceptance

by customer • Product goodwill products

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• Non – competition agreements (enforceable)

• Assume Vendor Willing Vendor Theory – if non-competition not in place

• Willing Vendor will do all that is realistically possibly to maximize price/value of business

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• Hindsight – events occurring after valuation date should not be taken into account

• Fair value – watch judge find another way to hand out justice

• Example – car rental businesses–Land value

• Can assess likelihood future event– foreseeable

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• The conclusions are estimates based on judgment – not precise

• Buyers expectations of the future and assessment of risk– -look at the stock market constantly now

changing 1-2 % a day based on anticipated effect of world events

– This is why industry/economic analysis is so relevant

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Other Asset Analysis

• Accrued Bonus Payable

• Shareholder Loan Analysis

• Need to look at:– Working trial balance and adjusting entries

– General Ledger printout

– Computerized Accounting records

– Sometimes need following years data

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Other Asset Analysis

• Need to ask company’s accountant what other assets exist as he did the accounting and also source of business valuation adjustments

• Need to look at lawyers NFP analysis to see other assets have been properly included

• Need to access present value of after tax analysis

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Where Can Financial Experts Help?

Preparation of requests for information

Preparation or Review Disclosure Documents

Preliminary Income/Value Calculations To Put File Into Perspective

Preparation of questions for discovery and during discovery

Objectively review your need of their service

Preparation of planning documents, expert opinions, critique reports

Forensic Analysis Tracing Of Gifts Tax planning strategies Attending settlement

hearings, arbitration and mediation hearings

Giving evidence at trial


• This is educational presentation and not specific advise to be relied upon each circumstances is different

• Questions?

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