How To Value a Business for a Divorce

Property division during a divorce can be one of the most contentious areas of the process, second only to child custody and child support. If one or both partners own a business, things can become even more intense. Regardless of whether one or both spouses own a company, the question of what it’s worth as marital property creates headaches and emotional trauma on both sides.

How a business gets divided depends largely on how your state divides marital assets in a divorce. Your business valuation will differ depending on whether you are in a community property state or an equitable distribution state. It also matters whether you own the business alone or jointly with your spouse.

This article explains the process of valuing a business in a pending divorce. If you have further questions, FindLaw’s Divorce and Business Ownership section can be a tremendous resource. Your family law attorney should provide additional legal guidance.

Valuing a Business

States fall into two categories for dividing property in a divorce. Community property states divide all marital property equally. Equitable distribution states divide property according to what seems fair or “equitable” in the marriage. When determining a business valuation in divorce, the company may be valued in several ways. These methods aim to determine the business’s “financial value” so it can be split between the parties. These include:

• The Income Approach estimates value based on cash flow or expected profits. This method suits businesses with few physical assets and a stable client base.
• The Market Approach determines the business’s fair market value by comparing it with similar businesses in the same industry or region. This is useful for competitive businesses such as restaurants.
• An Asset-Based Approach is used when a business has numerous saleable assets or equipment. Shipping companies or other large-scale companies may use this approach.

These valuation methods determine only the value of the business’s assets and liabilities. They can’t determine intangible values such as goodwill and spousal contributions. Let’s take a closer look at these two aspects.

Spousal Contribution

If only one spouse owns the business, the other spouse may still claim a share through spousal contribution. Courts consider how much a spouse contributed to the business’s success and what percentage of the business’s assets result from their help.

• Direct contribution (also called “sweat equity”) refers to the amount of actual work a spouse did in the business without pay. For instance, if your spouse did the accounting without pay for the first two years until you could hire a bookkeeper, that value is part of the business profits.
• Indirect contributions, such as maintaining the household, providing secondary income, and other support while the other spouse developed the business, can justify a claim to a portion of the business’s appreciation during that time. If your business was not profitable for the first two years and your spouse’s income kept the family afloat, your spouse can claim that percentage of the business’s profits.

Correctly estimating how much of an effect these can have is tricky. Be upfront and honest with your family law attorney when assessing how much of an impact your spouse has had on your business.

Goodwill

In most courts, business reputation and marketability are attached to the business itself and are divisible in a divorce. “Personal goodwill” is your own personal reputation and work skills. Personal goodwill is considered separate property. Professional business appraisers usually assess the value of goodwill, as it requires practice and market knowledge.

How To Get a Business Valued

Forensic accounting is usually required to get an accurate picture of a business valuation. In most divorces, each partner will have their own forensic expert. Forensic accountants review all aspects of a business, including:

• Income and cash flow: “Income reconstruction” can recreate the business’s actual income from financial records and locate any hidden assets or forgotten purchases
• Asset tracing: This prevents the concealing of business assets, allows the tracking of commingled funds, and helps locate whether community or separate property was used to purchase business property
• Tax analysis: Helps to determine the potential outcome of the sale or transfer of businesses between partners

If both spouses own a business, it’s probably in everyone’s best interest for one partner to buy out the other. Unless a buy-sell agreement is in place, selling a business could trigger tax consequences that could affect the divorce.

Discovery for Business Valuation

During a business valuation, you should work with a family law attorney who understands how business interests operate in marital situations. Property division of a business is a complicated tangle of separate, marital, and sometimes outside interests. Without all the information, the forensic expert can’t provide an accurate valuation or the evidence both sides need for the judge.

Discovery is the legal process for requesting documents from the other party in a legal case. In a divorce case, both sides may ask for financial statements and tax returns that the other side has already produced. The financial expert needs all documents to verify that everyone is working from the same figures.

Your attorney will request documents from the other party and ask for the information you need. In a business valuation case, this could include:

• A list of on-site inventory
• A list of accounts receivable and payable
• All bank accounts and numbers, including offshore and overseas accounts
• All investment accounts, IRAs, pensions, etc.

The forensic analyst needs to know the business’s total value, including tangible and intangible assets, to complete a valuation. High-value service businesses (law offices, medical practices) will likely include a list of customers or clients. Some partners may be unwilling to give these up, even in a divorce. Your attorney may need to resort to stronger methods, like a hearing before a judge, to compel production.

When You Must Have Legal Help

Divorce is complicated enough. When a business is involved, things can get extremely messy and complicated. Business valuation is difficult even for experts, and finding a good valuation expert can be challenging. Having a property-division expert on your side can be a tremendous asset.

Your family law attorney should also be experienced in divorces that involve a business. A legal advocate will review your marital estate, explain your options, and make sure your ownership interest in the business is part of the settlement.