Business Ownership & Valuation in a Divorce
In every divorce, there seems to be some sort of disagreement over the various assets involved. Among these assets are businesses owned by either the couple together, or one party. The question that becomes important is, “how do you value a business in a divorce?” This article seeks to provide a quick breakdown and basic overview of business valuation in a divorce scenario, so that you understand your legal rights in this situation.
Fair Market Value
The key term with which you should be familiar when dealing with a business in a divorce settlement is “fair market value.” This is the amount of money that a buyer could reasonably be expected to pay for the business if it were sold outright at that moment. Fair market value is not mandated by PA law, but is often used as a barometer to determine the business’ value, taking into account assumed scenarios including, but not limited to, the business continuing as a going concern were it sold, and that the hypothetical sale would be mutually agreed upon and not a takeover.
There are certain key issues that must be addressed before the valuation can be completed. In the case of a company that is comprised of multiple entities, the valuation analyst must have a complete understanding of which entity is being valued. The analyst must also have an understanding of the ownership interest involved—is it a minority interest of less than 50%? If so, discounts must be applied due to the “owner’s” lack of control and marketability, and the lack of a ready market for the situation.
The analyst must also understand as of what date the business is being valued, as assets and fair market value can change from day to day in a fluctuating economy. Normally, one of two dates is used—the date of separation or the date of distribution.
Finally, the analyst must determine the standard of value being used, particularly if a standard other than fair market value is being used, such as intrinsic or investment value, and the premise of the value—is the business being valued as a going concern or to be potentially liquidated?
Certain issues must be accounted for when undertaking business valuation. For example, the business owner can use bookkeeping tricks like including personal expenses in financial reports to artificially decrease the value; conversely, the spouse without ownership can levy accusations that the business is worth significantly more than the fair market value.
The first activity, while common, is representative of unethical practice, while the second generally stands simply to drag out the divorce proceedings.
Conducting the Review
Once preliminary issues are settled, the analyst reviews the company’s financial data and analyzes depreciation schedules, financial forecasts, salary information, and other relevant factors in the business’ financial information, as well as conducting a site visit and an interview of management and key personnel.
Once the expert has a clear picture, several methods can be used to determine fair market value. These include:
- Income-based approach: This approach calculates the business’ value based on the current benefit stream, often after a cash flow statement adjustment and the application of a discount rate.
- Market approach: simpler than the income-based approach, this compares the business to others in the same industry and region with similar sizes.
- Asset-based approach: the simplest method, this approach adds up the values of all assets possessed by the business, and then adjusts the assets based on historical values to current market value.
Finally, the analyst must consider goodwill and asset sales taxes. Goodwill comes into play when the business owner’s personal reputation drives the practice, such as with a doctor’s private practice. Butler v. Butler saw the PA Supreme Court rule that personal goodwill is not subject to equitable distribution, but if the goodwill is attributable to the business it is subject to distribution. The expert has to consider the driving forces behind the goodwill when performing the valuation.
When considering asset taxes, Balicki v. Balicki reaffirmed that any tax ramifications of the sale of marital property must be considered, regardless of whether a sale is pending or under discussion.
Who Gets the Business?
A Business is often considered a significant asset in divorce proceedings, and what exactly happens to the business depends entirely on the individual divorce proceedings. While it’s unfortunate, there are several possibilities as to the fate of your business. Some of these possibilities are:
- You keep the business: In some cases, particularly in amicable divorce settlements, you may be permitted to keep your business. This can come with a minority co-ownership by the spouse, who is permitted a share of the profits, but doesn’t participate in active management of the company. It can also occur if your spouse already has a stake in the business and you buy out his or her interest.
- Your spouse gets the business: This is the worst case scenario. If the spouse pushes hard enough, he or she could potentially claim full ownership of the business. This result, however, is rare and would often include proof that you have mismanaged the business in some way. Another situation in which this can happen is if both spouses have ownership interest, and your spouse buys out your interest, allowing him or her to take over.
- You lose the business altogether: In some cases, it is determined that the business will be sold outright, and the assets from the sale be divided between the two parties. This often happens in a situation where both spouses have an ownership in the business, and one is not willing to allow the other to buy out ownership.
- You share the business: In some situations—again, most often in amicable divorce cases, the spouses can agree to co-manage the business together, drawing up a new partnership agreement and proceeding as any set of business partners might.
Performing a business valuation is a complex procedure, and the valuation analyst must have a strong knowledge of all of the pitfalls and issues involved, and have a clear and complete picture of the business being valued, so that the best solution in divorce proceedings can be reached.