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DEBT Is a Four-Letter Word

By Kathy Hensley and Rob Schlegel

Has your divorce client's business been caught in the recent economic crisis? Most industries, such as retail, wholesale, construction, and services, are affected. Although there are a few exceptions, the presence of debt in a business elevates risk, which depletes divisible asset value. The presence of loaned money to the business (most often, from a bank) indicates leverage, or the concept of “using other people's money” to fund the business. Higher financial leverage is fine during periods of expansion and growth, but during contractions, high leverage actually penalizes a business and makes it more vulnerable to bankruptcy.

Matrimonial attorneys must be able to distinguish elements of leverage risk that are accentuated in today's economy in order to prevent overvaluing business equity. In some cases, common valuation techniques that ignore leverage can actually undervalue a business that is less risky and able to weather the economic storm. These latter businesses will be best positioned to take advantage of growth when the recession ends, and may be valued higher because of conservative strategies followed during 2007 and 2008.

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