Valuing Businesses During Divorce

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Today, more and more individuals own their own business, either as a sole proprietorship, a partnership or some form of limited liability entity (an LLC or a more traditional corporation). When a spouse owns a business at the time of a divorce, 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 an equitable claim. If one spouse starts a business during the marriage, all of 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, would be considered marital property unless the parties agreed otherwise in a prenuptial agreement.

How do courts value a business?

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 in a given year but still have positive equity. And 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 court has two options generally in valuing a business – its book value (net assets) or market value (earning capacity). The method chosen could dramatically alter the value, particularly if a business intentionally is draining assets to show low value on the books or has been tanking purposefully to lower its market value.

A smart way to handle these issues will be to hire an accountant to conduct a valuation of the business using both methods and going back at least five years to compute an average as well as a trend projection for income.

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 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 an expert to conduct a proper valuation.

If you have questions about valuing a business during divorce, contact us – we can help.