A Professional Valuation Is Key

As a business owner, you already understand the importance of business valuations. Knowing proper values for your business assets smoothes transitions, sales and liquidations. Unfortunately, many business owners neglect to obtain a professional valuation when preparing to divorce their spouses. Because emotions are typically negative -- anxiety, anger and mistrust -- one spouse may suspect that the other is hiding or undervaluing significant assets in an attempt to keep them out of the divorce settlement. This suspicion often arises when a family-owned business is at stake. Divorce is never easy. But, as a business owner involved in a divorce, you can take steps to make the marriage dissolution as painless as possible. The first step is consulting a reliable, impartial, experienced valuator. The next step is preparing and educating yourself about the ins and outs of valuing assets for divorce purposes.

Key Points of Divorce-Related Valuations - Keep in mind that each state has its own laws and legal precedents in divorce cases. Your valuator should understand how these laws affect the valuation process, but consulting an attorney is also essential. Beyond state law and precedent, other characteristics differentiate divorce-related business valuations from others. Let’s take a closer look at these points and their implications for the valuation of your business.

Marital Property - This is property you acquired during your marriage, regardless of how title is held. But marital property usually excludes property you or your spouse acquired before the marriage or through gift or inheritance during the marriage.

Community Property - This assumes joint and equal ownership of marital property acquired while you were married.

The Valuation Date - This can be: 1) the date of separation, 2) the date of the divorce filing or 3) the date of the divorce. Make sure the valuation date is fixed at the start of the valuation engagement. Otherwise, date discrepancies may invalidate the valuation.

The Standard of Value - The standard of value can be a minefield. One unique aspect of finding value for a divorce settlement is that the valuator is typically not seeking the business’s investment value. Because the business usually isn’t going to be sold, its value to a specific buyer isn’t particularly relevant. Although many of the considerations are the same as for determining sale value, some substantial differences exist. As with the valuation date, all parties should agree on the standard of value at the start of the process. (See “It’s Not Necessarily Fair (Market Value)” on page 3.)

Buy-Sell Agreements - Your valuator should be familiar with your state’s precedents regarding buy-sell agreements. Some state courts ignore the agreements, while others consider them valid.

Adjustments to Financial Statements - Your valuator may need to adjust your company’s financial statements in several areas. For instance, as the owner, you may have drawn too much or too little compensation compared with the amount a hypothetical buyer would pay a manager.

Or your nonparticipating spouse may claim your business made more money than the amount reported on its tax returns. If the valuator doesn’t adjust the financial statements to include the income, your company may be undervalued. On the other hand, if the valuator includes this income, the IRS may come after your company.

Practice and personal goodwill - Practice goodwill considers such factors as the business’s location, work force quality and required licenses. Personal goodwill focuses on you, as the owner, and includes your age, health, personal reputation and involvement with the business. In general, practice goodwill is considered marketable but personal goodwill is not -- unless an enforceable agreement requires you to continue involvement with the business or practice and bars your competing with the practice.

Non-compete agreements - In most states, non-compete agreements are not considered marital property. If a considerable part of your business’s value is predicated on or would be allocated to a non-compete agreement with your spouse retaining the business, your valuator must be aware that this value isn’t part of the marital estate.

In Court - If you and your spouse are unable to agree, the court will decide. Your valuator must persuade the court that his or her figure is the most accurate one. Whatever method the valuator uses, the figure must be defensible. The report should provide compelling evidence for that figure. Vague or unsupported numbers won’t hold up in court.

In almost every divorce case, the court awards the business to one spouse. Rarely does the court order selling the business. But if it does, the court usually asks the valuator to determine a formula to allow one spouse to buy out the other.

A Balancing Act - Valuing assets in a divorce matter is like walking a tightrope, attempting to negotiate a difficult transition -- without falling. We are experienced with this type of work. Please call us if you anticipate needing a business valuation as part of a divorce settlement.

It’s not necessarily fair (market value) - A divorce settlement includes the concept of equitable distribution, which isn’t a factor under a premise of fair market value. The meaning of equitable distribution varies from state to state. The general idea is that the court, which is supposed to judge the best interests of the parties involved, decides the settlement. This differs from a sale, where the parties are presumed able to look out for themselves.
Your attorney should define the standard of value and research whether the court in that state will permit any discounts. Some state courts are reluctant in divorce cases to allow various discounts common to fair market valuations, such as a “key person” discount if that person is one of the spouses and he or she intends to continue working in the business.

In addition, some courts may not allow discounts for difficulties in getting financing for a buyout, poor product diversity, low marketability or unaudited financial statements, arguing that these problems are relevant only to potential buyers.