One of the most challenging aspects of divorce is the division of assets. Depending on the marriage and the assets accumulated during this time, dividing these fairly between spouses may need to involve professionals, especially when it comes to valuing and dividing a business. With the different approaches to valuation and the aspects of a business that they focus on, the outcome of the valuation may differ substantially from method to method.
In this article, we will outline and explain these different approaches in valuing a business for the purposes of a divorce.
Separate or Marital Interest
The first step in valuing a business for the purpose of divorce is to determine how the value or interest in the business should be split. In making this determination, the date of the start of the marriage and the founding date of the business is taken into consideration.
If a business was started prior to the marriage, it is considered to be separate and not a marital asset. That being said, it does not mean that the spouse who is not an owner should not have an interest in it. If income from a non-owner spouse was spent on the business in order to help it develop or grow, the non-owner spouse is entitled to a degree of profits as a result.
How to Value the Business Interest
When it comes to valuing a business, the business’ organizational structure is taken into consideration. This is because, by their very nature, some business structures may have their own institutional regulations that determine how they are valued and divided when it comes to a business founder or owner getting divorced. For example, in the case of a sole proprietorship, the business is divided exactly in half between the spouses. For limited liability companies, the valuation may be determined by the laws of the particular state where the company is registered. If the company is a corporation with shareholders who may receive dividends from the business, this will need to be taken into consideration upon the valuation of the business as well as the division thereof.
Once the company structure has been considered, there are three main ways in which to complete a business valuation for divorce purposes. These varying approaches focus on aspects such as assets, the market, and income respectively. We will provide a simple explanation for each one.
1. The Asset Approach
The asset approach employs a simple formula of assets (both tangible and intangible) minus liabilities. At first glance, this may seem to be a simple approach but it can become complicated. When it comes to placing a value on assets, different people have different approaches to doing these valuations. Items such as vehicles of computers may be relatively easy to place a value on while other items such as inventory or office equipment may be more challenging. Due to the complexities this approach can involve, it is often used for divorces which concern the valuation for small businesses.
2. The Market Approach
The market approach assesses and evaluates other businesses of a similar size that have recently been sold. This approach can be likened to the way in which houses in a neighborhood are evaluated. In the event that there are no such similar businesses that have been evaluated and sold, this approach may not be suitable and the spouses will need to consider the other two approaches for valuation purposes. The reality is that in many cases, it is very difficult to find other business comparisons that closely mirror that of the company to be valued. For this reason, this approach is the least commonly used of the three.
3. The Income Approach
The income approach focuses on the revenue of a business and uses past performance to predict what the future income of the business may be. This valuation method focuses predominantly on projected cash flow and profits. Of the three approaches, this is the most commonly used when it comes to valuing a business for the purpose of divorce. Income is generally defined as the total value of proceeds from all goods and services sold by a business. This income includes any investment-related proceeds.
Completing the valuation
Who completes the valuation of a business in the case of divorce really depends on the particular situation. If the going concern is relatively small and there is no dispute as to its value, the spouses themselves could reach a conclusion. Attorneys may also be used in this instance to evaluate and stipulate a value on the business.
In the case of bigger companies that turn over bigger profits, a business expert may need to conduct a full evaluation of the business including aspects such as its history, performance data, and financials. These business experts usually hold accounting degrees or are Certified Public Accountants (CPA).
If the stakes are high and the value of the business will have a big impact on both spouses, either spouse may hire their own professional to conduct the valuation. If there is ever a dispute as to the agreed value, a judge will make the final decision.
The Date of Valuation
The date upon which the valuation is concluded is significant due to the extended time it may take for divorces to be concluded. During this time, the state of business affairs may change. If there is a hearing involved in the divorce proceedings, it is advisable to conduct the valuation as close to the hearing date as possible. It is important to note that should the spouses decide to make use of experts to value the business, the cost of the overall process and most specifically legal fees will increase dramatically.
Things to consider
There can be a number of downsides or aspects to be cautious of when having a business valued during divorce proceedings. One of these is the goodwill of a business and how this is considered by different parties. Goodwill, as it relates to business, refers to customer loyalty based on the owners or employees who work within the business. If one of the spouses is considered to have a significant impact in this regard, value is placed on this fact and it is subtracted from the overall valuation of the business.
Another aspect of business valuation to consider is that of ‘double-dipping’. This is the counting of an income source related to the business twice. It may be calculated as business revenue on one side and then as individual income for the spouses on the other side.
As we have seen, the valuation process of business during divorce proceedings can be complicated. If this is the case, using professionals to value the business may be the best solution for the spouses. What needs to be discussed is whether the additional costs incurred are justified in the overall process. Using a professional does not necessarily need to involve an all or nothing approach. You could make use of a professional’s time for a few hours in order to gain the guidance you may need.
We hope that this guide has provided valuable insights into divorce and business evaluation and how this is carried out most effectively.