Splitting Private Equity Assets on Divorce: Why It’s So Complex

Splitting Private Equity Assets on Divorce: Why It’s So Complex.

Splitting private equity (PE) interests on divorce can pose a number of difficulties. As these assets can be illiquid and may not have reached maturity, it can be complicated for couples to understand how to split such assets, or offset them against another, such as property, when it comes to the financial settlement.

Getting it wrong can result in a detrimental financial position for one or both parties immediately following the divorce or down the line, so it’s important both individuals understand how the legal process can help and support decision-making over such assets.

Equally, it’s important to understand that trying to hide such assets from the legal process, in the hope they won’t be factored into the financial settlement from the divorce won’t be taken lightly by the court and could result in harsh financial penalties.

How Courts Value Private Equity Interests in Divorce

Here’s how the court will factor PE assets into financial remedy proceedings

Valuation: Firstly, the court will instruct forensic accountants to provide an accurate valuation. They will ask for information about the type and structure of the fund, when it was acquired, and each parties investments into it during the marriage. They will also consider how much of the asset should be considered as part of the matrimonial pot, if the PE asset was invested in before the marriage or after separation.

They will also look at where the fund is, in its lifespan - normally they run for ten years, as well as the liquid and illiquid facets of them. These experts will also take into account how a PE professional’s financial pot may be a combination of salary, bonuses and investment returns.

They will examine Limited Partnership Interests (fund stakes that may appreciate over time), Co-investments (direct investments into the equity of a business that tend to have preferential terms, adjacent to the fund) and Carried interests (a fund’s profits if the returns surpass a certain level) to get the full picture.

To ascertain the value from this information, these experts will then use discounted cash flow analysis to predict the money it could produce throughout its lifespan, with risk adjustments – accounting for uncertainty and illiquidity through discounts.

Legal Mechanisms for Dividing Private Equity in a Financial Settlement

Splitting or offsetting: Now the court has a clearer picture of the PE asset/s’ value, it will encourage, and order (if the parties cannot reach an agreement themselves) to follow the following mechanisms to achieve a fair split, and a clean financial break if possible at the point of divorce, or down the line until the PE asset has matured. These include:

• Deferred Sharing - deferring the split of the PE asset until it reaches maturity. This is favourable when there is likely to be carried interest. But it means both parties may have to continue to paying in if the fund makes capital calls. And there isn’t a clean, immediate split.

• Structured Payments – as the fund increases in value, each party will receive their return under a structured payment plan. But these plans can be changeable because a fund can be so unpredictable.

• Immediate Offset - a lump sum settlement is given to one party to offset the other party’s PE assets. For example this could be in the form of liquid assets such as savings, or illiquid such as property. Whilst forensic accountants will apply a discount to the valuation, to account for adverse market conditions, there is also the possibility it may do unexpectedly well down the line, meaning the other party could lose out to profits.

Risks of Splitting or Offsetting Private Equity Assets

The courts will take a bespoke approach to each party’s financial and family needs, and their wishes following the split, to decide which mechanism should be applied to come to a financial settlement. There are always risks with investing and splitting such PE assets, but the court will do its best to achieve a fair decision for both parties.

How Lawyers and Financial Advisers Guide Private Equity Division

For each party, it is always worth exploring each scenario with lawyers, to understand how it impacts the matrimonial pot, and each individual’s future financial prospects. Lawyers will also be able to coach each party through non-dispute resolution routes, such as mediation or private financial dispute resolution that may help each party come to a quicker decision, and be less costly overall. In collaboration with financial advisers, they can also ensure the asset/s’ tax liabilities are taken into account and structured efficiently.

The Role of Pre- and Post-Nuptial Agreements in Private Equity Divorce Cases

Although unsentimental, it is wise for couples with such assets to consider pre-/post-nuptial agreements, that could make this division more straightforward, come to a financial settlement quickly and help parties understand their entitlements from the outset. Keeping all paperwork about the fund will also help lawyers and financial advisers reach a speedier resolution for the parties too.

Julian Ribet, Founding Partner at Ribet Myles, a boutique law firm specialising in family law