Divorce: How are Personal Guarantees on Business Debt Handled ?

It is a common situation where one spouse owns and operates a privately-held business and the non-owner spouse agrees to guarantee some portion of the business debt.

This blog post will examine how personal guarantees for business debt are dealt with in the context of a divorce.

The use of a simple example can illustrate some of the issues that are at play:

Suppose that a couple is going through a divorce. Assume the husband (Mr. John Smith) owns and operates a business through a privately-held company, of which he is 100% shareholder. Let's pretend this corporation has $100,000 in loans from the bank and that Ms. Nancy Smith has personally guaranteed the full $100,000. Nancy is NOT a shareholder of the company.

The question is, how is the personal guarantee from Nancy dealt with now that the couple are divorcing? Is it a liability for Nancy?

Possibly. It is a contingent liability. In other words, it is a liability that may come to fruition.... but may not.

What is a Right of First Refusal ??

When a privately-held company has more than one shareholder, a right of first refusal (“ROFR”... sometimes pronounced as "roofer") is an agreement among them as to how potential sales of shares to third parties are handled.

ROFRs provide procedures on how potential future share sales are managed.

Example:

Suppose Sam and Tom each own 50% of a privately-held company that produces video games. Tom is tired of dealing with Sam, and he wants to retire so he has found a buyer willing to pay him for his 50% of the company. Sam is not thrilled with this since he doesn't want to be stuck with a new 50% shareholder he knows nothing about.  Also, Sam would like to own 100% of the company himself, if he can manage it. Sam remembers that when he and Tom executed their shareholders' agreement that there was a ROFR clause included in it. Sam has decided to exercise his ROFR and will pay Tom for his shares at the same price and terms that were offered to Tom by the third-party purchaser.

A background on rights of first refusal

There are essentially two types of rights of first refusal:

How is the Child Support Amount Determined in a Divorce?

In the divorce process in Canada, once the spouses have worked out the child access details, living arrangements, and so on there still remains the question of child support payments. More specifically, how is the actual dollar amount determined?

The parent who does not have the primary care responsibility for the child (or children) is usually responsible to pay child support to the parent that does. The amount of child support is determined based on the Federal Child Support Guidelines (“FCSG”), which is statutory.

The FCSG are set up to ensure a level of consistency and fairness when it comes to determining the actual amount of child support that must be paid. The FCSG provide guidance as to the procedures involved in calculating what is known as “guideline income” (i.e. the income amount used to determined child support). It is VERY important to understand that guideline income under the FCSG is not necessarily equal to accounting income or income you report on your tax return. Also, either party can request income disclosure from the other party once every year.

How to Value a Business

This blog post will give a high level overview of the principles involved in valuing a privately owned business.

First thing to consider - is the business a going concern?

If the business is not expected to be able to carry out its financial obligations or remain viable, solvent and remain operating then generally the business would be valued on a liquidation basis.

In a liquidation basis, the assets would be valued at the amount they would be able to fetch if they were sold off, net of disposition costs, corporate debts, corporate taxes and personal taxes. In a liquidation approach, it is important to understand if it is to be a forced immediate liquidation or an orderly timely liquidation. In a forced liquidation the assets might not fetch as much money if they are to be sold off quickly, costs might be higher and generally the resulting valuation in a forced liquidation would be lower compared to an orderly liquidation.

However, if the business is a going concern, then there are three main approaches that could be used:  the asset approach, the income approach or the market approach.

The Asset based approach

If the business you are trying to value does not have commercial goodwill, or if it is generating a return that is below what should normally be realized for the assets invested in the business but it is not quite at liquidation yet, then an asset based approach would probably be the primary approach to value the business.

In an asset based approach, generally the assets and liabilities on the company's balance sheet are restated to market values. There is some more nuance to this approach that involves some technical items like lost tax shield, deferred income taxes and other items but at a high level the idea is to restate the balance sheet to current value, make some technical adjustments to a few specific items, then the restated equity (also known as the adjusted book value) would be the resulting value. In an asset based approach the key point is that there is no economic goodwill in the business that is being valued.  An asset based approach is also usually used when valuing a holding company.

Income based approach

If the business does have economic goodwill then you would likely want to look at valuing the business using an income based approach. In an income based approach, the business is valued using it's earnings or cashflow.

What is EBITDA?

Financial professionals are sometimes guilty of throwing around jargon without stopping to realize that most (normal) people might not know what they are talking about. EBITDA is one of those terms. Although it is fairly easy to define, there is some nuance to it. This blog post will attempt to shed some light on the financial term "EBITDA" and highlight why it is important.


What does E.B.I.T.D.A. stand for?


Earnings Before Interest, Taxes, Depreciation and Amortization.


EBITDA is an important financial measure of a business's profitability but you won't find it in an accountant's financial statement. The reason for this is that EBITDA is more of finance term than it is an accounting term. It is the profit that a business makes before any interest on debt, taxes or depreciation and amortization. It must be calculated separately from the information that is presented on your accountant-prepared financial statement.


So why go to the trouble of calculating EBITDA? Why not just use net income as reported on the financial statement?


There are a few reasons why you might want to calculate EBITDA versus relying on net income. The first reason is comparability. If you were analyzing several companies in an industry for their efficiency, profitability or relative valuation, net income would distort your analysis. The reason for this is that 2 similar companies with the same revenue and profit margins can report very different net income amounts. The reasons are that one company might be financed by a lot of debt and the other company might be financed by equity. The company that has debt would have interest payments that

Business Price vs. Value... what's the difference??

“Price is what you pay for, value is what you get.”  - Warren Buffet


There are many business valuation-related terms used that may lead to some confusion. This blog post will focus on clarifying some common misunderstandings. Specifically, this blog post will focus on clarifying some of the differences between business price vs. value.


What is business value? Is it the book value from a company's financial statements?


Most likely... not. A company's book value refers to the balance sheet value of a company. It is the company's balance sheet assets less its liabilities. On the balance sheet, asset values are normally listed at historic cost amounts and possibly some level of depreciation charged against them. They usually do not reflect the actual values that they can fetch on the marketplace.


If you were looking to sell a company you would most likely NOT sell it for its book value. The big reason for this is that book value does not include the economic goodwill of the business.


For instance, imagine a dental practice. The practice has all kinds of equipment, supplies, tools, computers, furniture and other items. However, if the business was bustling with an established patient roster and lots of revenue and profit then the dentist would not want to sell you the practice for merely the book value of the company. He or she would want some consideration for the patients that keep coming back to him and the reputation of the clinic. This is the economic goodwill.


So... book value is an accounting term. It is not true economic value.

The "Shotgun Clause" - what is it, and is it fair?

The shotgun clause is an often cited tool used in shareholder agreements to provide liquidity to shareholders. This blog post will briefly examine the shotgun clause and discuss some pros and cons.

What is a shotgun clause?

Simply stated, it is a type of buy/sell agreement between shareholders or partners in a business. The shotgun clause is usually added to a shareholders agreement in order to provide shareholders with liquidity in case one wants to exit the business or partnership. It is usually provided as an option of last resort in cases where the shareholders can't agree or have a significant difference of opinion and need to go their separate ways.

A simple example...

Sam and Tom are 50% partners in an incorporated business that manufactures desserts. Sam wants the company to focus on salty treats but Tom disagrees and thinks sweet treats are the way to go. The two shareholders are at an impasse. According to their shareholders' agreement, they are each entitled to call the shotgun clause in cases where they are at an impasse and need to go their separate ways. Therefore, due to his difference of opinion with Tom over sweet vs salty, Sam would like to use the shotgun clause in their shareholder agreement.

As a first step, Sam would need to set an offer price for Tom's shares.

After Sam offers a price to Tom for Tom's 50% of the company, Tom would then have the option of either:

• accepting Sam's offer or, instead,
• Tom could buy Sam's shares at the price that Sam had offered for Tom's shares.