What happens when legacy, loyalty, and litigation collide? For attorneys representing family-owned businesses, the valuation process often uncovers more than just numbers. From off-the-books perks to underpaid relatives, these enterprises can present complex, fact-intensive scenarios that demand forensic scrutiny.
With family enterprises representing more than 60% of privately held companies in the U.S., their valuation is often a pivotal issue in disputes over divorce, shareholder oppression, tax compliance, or succession planning. Yet their informal management style and personal entanglements can complicate even the most fundamental assumptions behind fair market value.
As business valuation and forensic accounting professionals, we’ve routinely encountered four recurring challenges that attorneys should consider when engaging experts in these cases.
1. Related-Party Compensation: Is Payroll Inflated or Distorted?
In family-run businesses, payroll often serves dual roles: compensation and succession planning. Nepotism may skew hiring decisions, and salaries may not reflect market rates or job responsibilities.
In litigation, this matters. For example, in a shareholder dispute involving a second-generation manufacturing company, our analysis showed that two family members employed in non-operational roles received six-figure salaries and luxury vehicle stipends. We normalized these expenses to reflect what a third-party buyer would pay in a true arm’s-length scenario, resulting in a material adjustment to the company’s earnings base.[1]
Practical Considerations:
- Does the family member have qualifications commensurate with their pay?
- Are perks such as country club dues, personal travel, or under-reported cash compensation distorting EBITDA?
- Is there documentation or only verbal justification for compensation decisions?
Valuation Impact: Adjustments are often made to normalize cash flow by removing excess or insufficient compensation, including payroll taxes and fringe benefits, per AICPA SSVS No. 1 guidelines.[2]
2. Non-Arm’s Length Transactions: Are Contracts with Family Members Skewing Cash Flow?
Related-party transactions- whether sweetheart leases, below-market supply agreements, or personal loans- must be evaluated for economic substance and fairness.
Consider a divorce case we handled involving a boutique apparel retailer whose inventory came exclusively from a designer cousin at 30% below wholesale market rates. We adjusted the cost of goods sold to reflect market pricing, which substantially reduced the business’s valuation for equitable distribution purposes.
Red Flags for Counsel:
- Rental or supplier agreements between the business and a family member
- “Loans” from relatives with no repayment terms or interest
- Asset transfers lacking documentation or consideration
Valuation Standards Applied: Per Uniform Standards of Professional Appraisal Practice (USPAP) and NACVA Professional Standards, the analyst must test whether these transactions reflect the behavior of a hypothetical willing buyer and seller, both acting in their own best interest.[3]
3. Informal Management and Weak Controls: A Breeding Ground for Risk
Family businesses often run on trust until that trust erodes. Informal management practices, reluctance to adopt financial controls, and aversion to outside advisors can expose these companies to fraud, inefficiencies, or biased decision-making.
In one forensic investigation, we uncovered that a controlling shareholder paid personal credit card bills through the company’s account, masked as marketing expenses. These findings became central to a derivative action filed by minority shareholders alleging misappropriation and breach of fiduciary duty.
For Attorneys Preparing for Trial:
- Expect few formal job descriptions, KPIs, or board minutes
- Examine cash controls and expense classification policies
- Look for signs of self-dealing or related-party perks disguised as corporate expenditures
Valuation Risk Consideration: Internal control weaknesses often result in a risk premium or discount rate adjustment to account for uncertainty in financial reporting.[4]
4. Key Person Dependency: Is There a Hidden Discount?
Family firms frequently revolve around a single charismatic founder or family leader. But that reliance can depress value, especially when that individual lacks documented institutional knowledge or succession plans.
We recently appraised a food services company where the founder negotiated all major contracts and had exclusive customer relationships. His unexpected death left the business in disarray. We applied a key person discount, justified by lost revenues and staff turnover, that attorneys used in mediation to support a discounted buyout offer.
Counsel Should Assess:
- Is there a viable succession plan?
- Have key relationships been institutionalized or remain personal?
- Are key employees under contract or insurable?
Quantifying the Discount: Based on expected monetary loss or through qualitative criteria such as turnover, client dependency, and management structure. Courts tend to accept key person discounts when they are tied to specific financial risk, not just a vague fear of disruption.[5]
The Coming Wealth Transfer
According to PwC’s 2024 U.S. Family Business Survey, 45% of family businesses expect a leadership transition within five years, but only 34% have a documented succession plan.[6] This gap, especially in contentious or high-value estates, creates fertile ground for valuation disputes.
In the wake of increased IRS scrutiny of estate freezes and grantor trusts and state courts growing wary of “family discounts” used to reduce marital assets, attorneys must proactively engage financial experts who can parse economic reality from familial fiction.
Valuing a family-owned business is never just about the numbers. It’s about credibility, context, and professional judgment in the face of interpersonal complexity. Whether you’re preparing for a buy-sell dispute, litigating a divorce, or navigating an estate controversy, our team brings the analytical rigor and litigation-tested experience that high-stakes matters demand.
If you’re dealing with a valuation dispute involving a family enterprise-or simply want to safeguard your client’s position before conflict arises-contact us to schedule a confidential consultation. You can reach Mark S. Gottlieb CPA/ABV/CFF, CVA, ASA at msgcpa@msgcpa.com or use the scheduling link on our home page.
Footnotes:
- IRS Revenue Ruling 59-60, Section 3.03.
- AICPA SSVS No. 1, VS Section 100.46–.48.
- NACVA Professional Standards (2024 ed.), Section VI; USPAP 2024–25, Standard 9, Rule 9-4.
- AICPA Practice Aid: Detecting Fraud in Small Businesses, Ch. 2.
- Shannon Pratt, Valuing a Business, 6th Ed., Chapter 18.
- PwC 2024 U.S. Family Business Survey, https://www.pwc.com/us/familybusinesssurvey