High-net-worth divorces can present plenty of obvious financial red flags. These can include attempts to hide assets, spending on extramarital affairs, or failure to disclose assets and liabilities. Sometimes, asset dissipation is hidden in plain sight, contained in the financial records of a closely held business. A business appraiser skilled in forensic methodology and experienced in complex marital matters can help fairly value a business when income and assets have been dissipated. This article summarizes three case studies of asset dissipation in divorce, specifically in a business valuation context.
What is Asset Dissipation and Why Does it Matter?
Dissipation in a marital dissolution context refers to the act of a transfer of assets to other parties or wasteful or unfair spending for the sole benefit of one spouse, either during the term of the marriage or during the dissolution or divorce process.1
In many cases, courts will adjust the division of marital property to account for dissipation, with the offending spouse receiving a smaller share of property if they have spent unfairly on new relationships, extravagant vacations, or transferred out cash or nonliquid assets. In the alternative, courts often assign the value of the dissipated asset to the offending party, generating a punitive effect on their attempt to mislead the court.
While a trained forensic expert can reveal dissipation in an analysis of personal bank statements and other independently prepared third-party documents, asset dissipation can be harder to pin down when one spouse owns a closely held business interest. Let’s look at three case studies that show how businesses (both successful and less so) can hide asset dissipation.
Case Study #1: A Successful Real Estate Brokerage
A successful real estate brokerage was founded and led by the husband of a divorcing couple. By any measure, the company was very successful, with over 50 employees and distributions to the husband, its sole owner, of $10 million over a ten-year period. However, a forensic analysis of the company’s operating results revealed discretionary expenses that needed to be adjusted to determine the fair market value of the company. As the husband’s interest in the company was determined to be a marital asset, the discretionary spending at the company indicated additional income available for purposes of determining spousal support.
- While expensing a car for business use is not unusual, in this case, the business paid for several high-end vehicles, including luxury sports cars, all for the owner’s use. The extra luxury vehicles cost the company approximately half a million dollars over a period of 10 years, causing the business to appear less profitable on paper. Ultimately, the business appraiser used a normalized level of automobile expenses based on a percentage of the company’s revenue, and costs above that amount were removed from its results of operations. A forensic expert, with sufficient access to supporting documents, could have also identified the non-business portion of these vehicle expenses, though such precision was not required in this particular case.
- Travel, entertainment, and meals expenses were also found to be excessive, even in years when the company incurred significant operating losses. Expenses in this category included luxury vacations, golfing fees, and tickets for sports venues. Normalization of these expenses returned approximately $700,000 of operating profit to the company’s results of operations.
In this case, the husband, in his capacity as owner of the company, made choices that significantly affected the available cash flow of his business. An outside investor, as presumed under the fair market value standard, would carefully scrutinize such costs to determine the actual future income that would be available from the business. Normalization of $1.2 million in expenses for luxury cars, travel, and entertainment revealed a more accurate picture of the company’s value and available income. This analysis, therefore, provided the court with a more accurate overall depiction of the marital estate.
Case Study #2: A Middling Trucking Company
A single-member LLC trucking company was founded and owned by the husband of a divorcing couple. The company provided same-day freight trucking for e-commerce and wholesale companies, generating up to $5 million in annual revenue. Over five years, the owner’s annual distributions ranged from approximately $60,000 to $600,000, with an average of approximately $200,000. As a trucking company, it held significant assets in the form of its vehicles, though some vehicles that were used in its operations were leased. The husband initially stated that the company’s worth was likely limited to the total of its vehicle inventory, minus related liabilities.
However, a forensic analysis of the company’s books and records revealed that a luxury vehicle and a sports car were also purchased through the company, though neither was used for business purposes. More troubling, forensic analysis of the company’s bank statements revealed multiple transfers to the owner’s personal bank account, erroneously identified as business expenses. Neither the luxury vehicle expense nor the bank transfers were apparent from an initial examination of the company’s books. Both issues were uncovered through a battle for appropriate discovery that eventually provided the necessary evidence.
Further analysis also revealed a scheme to utilize undeposited cash from company revenues to invest in cryptocurrency and precious metals. Overall, the significant cost of the luxury vehicles, together with the underreported cash transfers and scheme to invest undeposited cash, represented asset dissipation. Despite the husband’s initial claims regarding the company’s limited value, a more detailed analysis revealed that its operating results were artificially low, and the adjustment of its results led to a significant increase in the total value of the marital estate.
Case Study #3: A Family Concern
In our third case study, the husband of a divorcing couple owned and ran a network of interconnected businesses, including a plumbing services company, multiple real estate holding companies, and several other small concerns. With approximately 30 employees, the plumbing company represented the main source of income, with day-to-day operations managed by a non-owner CEO. Over three years, the company generated approximately $5 million in distributions to its owner.
Initial forensic analysis revealed that several expenses deserved further analysis. Six-figure legal expenses related to the parties’ divorce had been paid by the company, artificially depressing its value. As an additional complication, the company’s books incorrectly included expenses for the other related businesses, including a café and several residential real estate holding companies. Examination of the company’s books also revealed that three family members received W-2 wages, but only one of the three provided any services to the company. In the valuation analysis, the compensation paid to these “ghost employees” was adjusted out, and the third family member’s wages were adjusted to a market rate.
From a marital estate perspective, adjusting out the related-company expenses was a wash: the café and other small entities were 100% owned by the divorcing parties. However, the family member compensation totaled approximately $1 million over the three-year period analyzed.
When it came time to value the marital estate during divorce, the value of these payments to family members had to be added back to the value of the company in order to reach its fair market value. For the owner of this network of interconnected companies, the effect was that money “spent” by the companies in prior years, when not related to business purposes, became available to be distributed in a divorce, whether or not the company had that amount of liquidity.
No Stone Unturned
When valuing a marital estate that includes closely held businesses, as in these three case studies, a successful or even a middling business can hide significant asset dissipation. Uncovering such issues doesn’t have to be a game of hide and seek if you have an experienced business valuation and forensic accounting expert on your side. Business valuation professionals who are experienced in complex marital dissolution cases, including forensic discovery and analysis, can help clients feel secure that every detail in the marital estate has been included.
Connect with a CBIZ Valuation Professional today.
1 In Connecticut, under Finan v. Finan, dissipation requires the following to be proven: (1) financial misconduct involving marital assets, such as intentional waste or a selfish financial impropriety; (2) for a purpose unrelated to the marriage; (3) which occurs either in contemplation of divorce or separation or while the marriage is in serious jeopardy or is undergoing an irretrievable breakdown. A finding of dissipation allows the court to offset the value of the dissipated assets when dividing the estate.
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