Wednesday, November 5, 2008

Do I Need a Business Appraiser? And Just What is a Forensic Accountant?

Recently, Mark Ashton, in the Pennsylvania Divorce Lawyer and Attorney Blog, published an excellent post about how accountants can assist in a divorce case by setting a value on a business or by tracing financial transactions and producing a report. When the accountant testifies, s/he becomes a "forensic" accountant. Accountants can play a major role in preparing cases for settlement or trial. Attorneys will often work closely with accountants, exchanging information about the case and reaching conclusions about the financial aspects of the parties' community or separate property estates. The following is Mark Ashton's post, which clearly explains a lot about the key role accountants play in valuing businesses or in tracing assets:

"Many of our clients either own their own businesses or are married to people who do. In divorce the value of the business is a material aspect of equitable distribution and needs to be considered both for the income it produces and the value the business has. Figuring out the answers can be complicated and expensive depending on how honest the books and records of the business are.

"It may not come as a surprise to many readers to learn that some people use business accounts to pay utility bills for their homes, cell phones, college tuitions, car payments and personal travel expenses. It is not unheard of for a boy or girl friends to be a paid employee with benefits. Over the course of years, we have seen it all. The highlight or lowlight of this author’s experience was the business owner who put an addition on his home and booked it as an asset of the business. The same owner deducted his annual four month stay in Florida as a business travel expense even though he could not identify any work that he ever secured while enjoying the warmth of the Florida sun.

"So should everyone in a situation where the spouse owns a business hire accountants and appraisers? The question is not easily answered. A forensic accountant is one with specialized training to uncover fraud or misrepresentation. His or her job is to ferret out whether income is fully reported and whether all the expenses paid by the business are reasonable and necessary. If I buy your business chances are that I will not be paying your child $2500 a month to go to college or covering the Escalade you use to commute to work and charge to the company. Those are what are called 'add backs' because they are added back to what should be the real income of the business.

"The business appraiser takes what income and expenses are 'real' and attempts to determine what willing buyers and sellers would pay for the business. Thus, if your business earns $100,000 a year and pays your kid’s college and your Escalade, the real benefit of owning the business is probably closer to $150,000 a year. The business appraiser asks that question: 'What would a willing buyer pay to own a business that spins off $150,000 in income?' That is a function of many different integers. What is a reasonable rate of return? How much capital needs to be replaced each year to sustain the business? Is the compensation paid to the business owner fair given the work he or she supplies? What 'hard assets' does the business own? And, most importantly, what does the future look like in terms of potential growth. These are complex questions and the price for answers is not insubstantial.

"But reason needs to be part of the process. A business with one employee selling product using a desk and a phone rarely sells for a lot of money. You don’t need a forensic accountant to successfully argue that the children’s cell phone bills are not business expenses. But if the matter is complex and the business appears to have a value that a buyer would be interested in paying a substantial sum to take over, clients need to examine seriously the need to employ talented experts to tell the story in court.

"The starting point before engaging experts is for both the lawyer and the client to get the core financial documents and review them before the accountants and valuators become involved. Clients bring information to the equation that experts will never develop alone. The fact that valuation is a cooperative enterprise involving coordination and a common understanding of the objects at hand. Failure to do so produces an expensive and often unintelligible result."

Sometimes the parties to a divorce are able to cooperate enough to share a neutral accountant, but often a case ends up with dueling experts. (That's one of the reasons why I so strongly support Collaborative Law, which uses one neutral expert, but that's another topic.) Of course, cost can be a factor in using experts of any kind, so the parties and attorneys need to make sure both that there are sufficient funds to pay for the expert and sufficient assets to justify the expense. Not all accountants are qualified to do these tasks (just like not all attorneys are qualified to do family law), so qualifications and experience should be considered when hiring someone. The hiring, by the way, is normally done by an attorney, rather than the client. Your attorney can help you decide if the hiring is advisable.

Thanks to Sam Hasler of Sam Hasler's Indiana Divorce and Family Law Blog for his comments which drew my attention to the original post. Sam always has a wide variety of interesting posts on his blog.

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