Today, more and more individuals own their own business, either as a sole proprietorship, a partnership, a limited liability company, or as a traditional corporation. When a spouse owns a business at the time a divorce is filed, determining the value of the business can be a tricky matter.
Many spouses that own businesses obtain a salary through the business – but that does not equal the ownership value of the business. A spouse may make $50,000 per year through salary but have ownership interests in retained earnings of $200,000. Indeed, it is not uncommon for owners of businesses to try and hide their true earnings by taking a small salary and leaving most of the retained earnings in the business.
Any property obtained during the marriage is marital property to which both spouses have claim to receive an equity percentage of the value. If one spouse starts a business during the marriage, all the ownership interest in that business would be marital property. If the business started prior to the marriage, the increase in value in the business, at a minimum, could be considered marital property unless the parties agreed otherwise in a prenuptial agreement.
Any business has a net worth just like individuals – assets net of liabilities. However, businesses also have retained earnings or capital, often in the form of shares in the business. It is possible that a business could have a net loss each year but still have positive equity. Suppose at the time of the divorce, the business happens to have its worst year ever – should the court use that value as the value of the business?
A smart way to handle these issues will be to hire a business valuation professional to value the business. The business valuation professionals must define a standard of value before proceeding with an appraisal. A standard of value is a set of hypothetical conditions under which the business will be valued. In business valuations for divorce cases, there are two generally accepted standards: fair market value and fair value.
Fair market value is the price at which the property would change hands between a willing buyer and a willing seller when the former is not under any compulsion to buy and the latter is not under any compulsion to sell, and both parties have reasonable knowledge of the relevant facts. Under fair market value, many appraisers apply discounts, such as the discount for lack of control or the discount for lack of marketability, to obtain the value of minority interests.
The full meaning of fair value depends on the context of its use. While it is like fair market value in some ways, it typically does not involve the application of minority discounts. Fair value is dictated by the court with jurisdiction over your divorce case.
The two standards mentioned above can result in significantly different value estimates. In divorce cases, the business valuation expert must select the correct standard of value or their expert opinions may be dismissed by the court. An independent valuation can also help a spouse prove whether the other spouse hid certain assets or value or appeared to depreciate the earning capacity of the business for purposes of sandbagging an asset.
A court also needs to consider what investment the other spouse may have made during the marriage to the business. For example, if the business is an LLC for a physician, and the spouse helped pay for the other spouse to go to medical school or supported the other spouse during medical school, those investments can qualify as a percentage of the current business, based on the idea that without the help of the spouse, the other spouse would not have become a successful physician.
As you can see, many factors go into a business valuation, and it requires both an attorney with experience in handling these issues and retaining a business valuation expert to conduct a proper valuation.
Should you need the advice of a divorce and family law attorney or have questions or concerns about your situation, know that we are here to help and discuss those issues with you.