Business valuations in divorce cases are almost unavoidable in Missouri when one or both spouses are business owners. The common perception of business valuations in divorce cases gets unnecessarily expensive. That perception can become a reality if the spouses or their lawyers allow it to go on too long. The spouse who wants to retain the business might ask: (1) Does it have to be that way? (2) Can the evaluation process be efficient? (3) Can the business owner’s spouse not spend an outrageous amount of money? The spouse who wants the business valuation may ask: (1) Can the business valuation process go forward more fairly for the non-business owner spouse? (2) Can that spouse prevent the business owner’s spouse from artificially lowering the value of the business? (3) Can the requesting spouse avoid unreasonable and costly delays?
Does your business have a value?
Yes, every business has value. Small or large, a sole proprietorship, a partnership, a limited liability company, or a traditional corporation, there is no exception. Some simplify this “value” process by stating that value is what a buyer who is not in a hurry to buy will pay for the business and what a seller who is not in a hurry to sell will accept for the company. That is a simple way to look at it. Unfortunately, it is more complicated than that, and determining the value of the business can be a tricky matter.
Many spouses who 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 a 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 before 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?
What are the different ways to value a business during a divorce?
Business valuators usually take one or a combination of the following approaches when they value a business: (1) income-based approach; (2) asset-based approach; or (3) market-based approach.
Instead of going into detail about each of these approaches, here are the basics that you want to know. Every approach takes some or all of the following into consideration: (1) a business’ profitability (starting with a review of the business’ profit and loss statement); (2) the goodwill of a business; and (3) a business’ tangible and intangible assets.
What is a business’ profitability?
Business Revenue – Business Expenses = Profit.
Many self-employed business owners deduct business expenses that are not, by IRS standards, deductible. The expense may be partially deductible or not deductible at all. When measuring profitability, these nondeductible expenses may be added back into the equation, or the business valuator may simply remove them from the expense column. Either way, the result is an increase in the business’s profitability and the business owner’s income.
What is goodwill?
Goodwill is an intangible asset associated with the purchase of one company by another. Specifically, goodwill is recorded in a situation in which the purchase price is higher than the sum of the fair value of all visible solid assets and intangible assets purchased in the acquisition and the liabilities assumed in the process. The value of a company’s brand name, solid customer base, good customer relations, good employee relations, and any patents or proprietary technology represent some examples of goodwill.
What are business assets?
For a business that sells goods of some type, assets may include personal property. That is usually its inventory and equipment. It depends on the company and industry. For a professional service business like a law firm, you usually don’t see inventory and office items like computers, desks, etc. rarely have significant value. Such professional services businesses rely heavily on their goodwill.
Who conducts the business valuation during the divorce?
The spouses have three options available to them. First, the spouses and their respective attorneys can try and figure it out on their own. Second, the spouses can hire a joint forensic accountant to value the business. Third, each spouse can hire their own forensic accountant to value the business.
Should you and your attorney try to figure out the value of the business on their own?
No. This is a bad idea and the result will be an undervalue or overvalue of the company.
Should you and your spouse hire a joint forensic accountant?
A joint forensic accountant is one whom both spouses trust to provide a proper valuation and on whom both spouses rely for their attorneys to negotiate a settlement. You may automatically think that a mutually selected forensic accountant will cost less. However, that may not be the case. Why? Because you and your spouse may not agree with that accountant’s business valuation number resulting in one or both of you hiring his or her forensic accountant to review the joint valuation report.
Should each spouse hire his or her own forensic accountant?
Yes. The two forensic accountants don’t battle against each other. Rather, they each obtain the same information and determine the value of the business. In those situations where the forensic accountants both have reasonable arguments in support of their valuation, the spouses, lawyers, and forensic accountants can cooperate to reach a compromise value for the business. Nobody sane wishes for a contested divorce. A contested divorce results from disagreements. Disagreements are sometimes reasonable and sometimes unreasonable. If the spouses have reasonable disagreements that involve significant money, it may be best for the court to make the ultimate decision. That way, each spouse can have his or her forensic accountant testify in court and the judge can make the ultimate decision on the value of the business to be divided.
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 assistance of an experienced divorce and child custody attorney in Creve Coeur and O’Fallon or have questions about your divorce situation, know that we are here to help and ready to discuss those questions with you.