The Concept of Double Dipping in Business Valuations in a Divorce
In a divorce setting, “double dipping” is the term often ascribed to the inappropriate inclusion, or “double counting,” of the same economic value in both property division and marital support determinations.
As self-explanatory is its name, “double dipping” simply means the counting of the economic value in both property division and marital support determinations. Whilst this concept leans more toward the legal side of things, it does have a significant impact on business valuation.
Keep in mind that only complex divorce cases may involve this concept, under instructions with the divorce lawyers, otherwise this concept usually is not practised in most of the business valuations (for divorce cases) we handle.
We will explain it in this hypothetical scenario below:
The husband (CEO role) owns and operates 100% of a private limited company.
The husband’s total compensation from the business is about $200,000 per year and does not change much.
The average revenue of the private limited company is about $1 million each year.
Assuming that a business valuation has been performed, using the capitalisation of earnings method, that market-based, total compensation for the husband (CEO) should be $100,000 per year, and that a reasonable capitalisation rate for the company is 10%.
Now in this case, a potential “double dip” would occur if:
The husband’s total gross income is based on assumed, continuing the compensation of $200,000 per year
The company is valued based on a “normalisation” of earnings for the company including an assumption that the husband’s annual compensation should be lowered to $100,000. The normalization process would result in annual, expected earnings for the company increasing by $100,000
This increase in earnings for the company equals $83,000 on an after-tax basis (i.e., $100,000 in increased earnings reduced by a 17% company tax rate in Singapore).
Based on a 10% direct capitalisation rate (or an implied earnings multiple of 10 times—i.e., 1 ÷ 0.10 = 10), the normalisation process results in an increase in the value of the company of approximately $830,000 ($83,000 ÷ 0.10 = $830,000).
Now then, it is evident that the $100,000 reduction in the husband’s (CEO) compensation for valuation purposes would result in a higher business valuation.
Again we maintain that not every business valuation case in a divorce setting will involve this concept although it is good to be aware of such an occurrence.
If you think your case is complex and want to speak to a specialist, do not hesitate to contact us for a non-obligatory initial consultation.