We are increasingly being instructed to value businesses at dates in the past: the date of the marriage; the date of separation; and at the date of divorce.
The Courts are increasingly focused on determining the value of marital and non-marital assets and historic valuations form a key part of this.
Preparing a robust historic valuation is a process fraught with difficulties and, to add a further challenge, we are often asked to distinguish between active and passive growth in the value of a company.
We understand active growth to represent the proportion of any growth in business value generated by the actions of the owner/director whereas passive growth is the growth in value that could have been achieved in the absence of any specific activity.
In this article we consider both the concept of active and passive growth and another concept which has received a significant amount of ‘air time’ in recent judgments – the springboard effect.
Springboard value – sink or swim?
The idea of springboard value assumes that at a date in the past, say the date of marriage, a business which may be in its relative infancy could have a greater value than first thought as a result of actions which were undertaken prior to the marriage but in respect of which the financial impact will not be known until some time after the marriage.
As Seen On Screen
Take, for example, the matter of Robertson v Robertson . Springboard value was directly addressed in the judgment but the circumstances illustrate the concept neatly. At the date of the marriage in 2004, Mr Robertson owned shares in a little known clothing retailer which had been incorporated in 2000. In around 2010, the popularity of this retailer (ASOS) skyrocketed and is now used by millions. The boost in popularity (and thus value) of ASOS did not happen overnight but resulted from the efforts over a number of years.
Without a crystal ball, in 2004 the future prosperity of ASOS would not have been anticipated or taken into account in a valuation of the pre-marital asset, even though it may in part be as a result of actions undertaken prior to that date. In this case, the growth of ASOS was a little too far away from the date of the marriage to be significant, but the case demonstrates the point.
One simple way in which we have seen the idea of springboard value being explained (and one which was argued by the QC in IX v IY ) is suggesting that, at the date of the marriage, the company was “pregnant” with value.
Springboard value assumes the company will swim, not sink
Whilst the idea of springboard value may seem reasonable, from a valuation perspective applying an uplift in respect of springboard value is counter-intuitive because it is entirely reliant on hindsight (or the aforementioned crystal ball). Some companies will flourish as a result of pre-marital activities, others will fail. No-one seems interested in the reverse springboard argument, presumably because if the company is worth nothing at the time of the divorce it’s not worth fighting over.
Back to hindsight – when valuing a company at a date in the past, the valuer should only take into account information that would have been available or was known (or could reasonably be foreseen) at the date of the valuation. That makes logical sense – a purchaser acquiring a business makes a valuation decision at a point in time and pays on that basis. Purchasers don’t agree a price then come back a few years later and offer to pay more if the company has performed well or ask for money back if it has underperformed (well, it can happen but generally relates to a specific contractual claim). Of course, when we are preparing current valuations we don’t know with certainty what is going to happen next month or next year and can only factor in what we know or can reasonably anticipate.
50% of new business then fail in the first five years
The matters we have seen which consider springboard value are in respect of relatively young companies. According to recent statistics, 50% of new businesses in the UK fail within the first five years. Applying an uplift for springboard value is done with the benefit of hindsight and the knowledge that the company will be successful – disregarding the very real possibility that, at the time of marriage, things may not have turned out so well. After all, if Mr Robertson was getting divorced in 2004 (before ASOS was a success), he would no doubt have been keen to highlight the possibility that the company may not achieve its goals. A third party buyer would be reluctant to place much weight on optimism (and pay more) without some robust forecasts (which would be considered in determining the value).
Thus, the idea of springboard value appears to contradict one of the fundamental principles of business valuation.
That said, a number of recent judgments (including IX v IY ) have disregarded expert evidence and included an adjustment for springboard value in recognition of the pre-marriage contribution by the owner manager to marital value. The uplift in pre-marital value resulting from the springboard increases the value of the non-marital asset and appears to be an attempt to reach a fair conclusion. While we do not necessarily disagree with the sentiment behind the adjustment, the application of an uplift to represent springboard value is likely to be (to some extent) arbitrary.
Active and passive growth
Historic valuations are not new to us. However, the Courts are more regularly wanting to understand what proportion of the current value can be attributed to the historic value introduced on marriage, including passive growth in this value (non-marital value), and what proportion is due to the actions of the parties during the marriage – active growth (marital value). Marital value may arise from the direct involvement of one of the divorcing parties – a starring role – or a supporting role in the wings (or at home).
We consider the distinction between active and passive growth in depth where we have been instructed to address it – it is not a case of ‘one size fits all’. Some businesses are relatively passive in nature – think property or other investment companies. Changes may be made to specific assets but in general the growth (or decline) in value of those assets will arise more as a result of movements in the marketplace than from the actions of the company. The sharp drop in UK house prices that arose in 2009 and 2010 is likely to have directly impacted the value of property investment companies across the country despite any actions taken by the directors.
Trading companies are rather different. If management step away from a trading business it may continue to run but is unlikely to just keep ticking along – problems and challenges may not be addressed adequately and new opportunities not identified and pursued. Over time the value that has been built up would deteriorate.
So is that the answer? There can be no passive growth?
Recent judgments suggest no. We have seen, and calculated, the passive growth in the value of companies with reference to industry indices.
This approach to the differentiation could be viewed as determining active growth on the basis of special contribution – it assumes that, but for the special contribution of the parties during the marriage, the company would only have grown in line with the average company operating in the same industry. However, the average company won’t have grown passively. The assumptions underpinning this approach may be more or less appropriate in different circumstances and therefore need detailed consideration on a case by case basis.
There is no consensus as to the right way to determine passive growth
It will be interesting when we come across a scenario whereby a benchmark index suggests a company should be worth more than its current value (it is bound to happen). Does this mean the parties made a detrimental contribution or that there is a flaw in the index based approach?
Does consideration of passive growth negate the need for an adjustment for springboard value? Maybe. After all, any drastic increase in value is likely to be as a result of more recent actions rather than those taken prior to the marriage (assuming that there is a reasonable length of time between marriage and divorce).
The approach adopted in the judgment for Martin v Martin  did not separately consider springboard value or passive growth but approached the split of marital and non-marital assets in one fell swoop. The judge adopted what may be viewed as an even more arbitrary approach – applying a straight line apportionment to the increase in value of the business over its life span. Whilst this is a fairly straightforward way of apportioning value it is somewhat removed from reality – we have never seen a real business grow on a straight line basis.
The Court’s scrutiny of the distinction between marital and non-marital assets means that this area is likely to provide interest and intellectual stimulation for some time to come.