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Business Valuation in Divorce

Business Valuation and Dividing Businesses in Divorce

Divorce is already difficult with many emotions and complicated issues to address. Often divorce can be made even more difficult when a family business or closely held business is involved. In such cases, often a business valuation is required.  A business valuation will help the Court and the lawyers through settlement or mediation to determine the fair and equitable distribution of marital assets. Frequently, when people divorce they do not agree on the value of the business or one spouse who has been less involved in the business has no idea what a business should be valued at. In situations such as this, a business appraiser can provide a very valuable expert opinion about the value of the business. 

Generally business valuations will be done through one of a couple methods (although some valuations will look at each method and then determine the one that the valuator believes most fair in the circumstances): an income-based approach, an asset-based approach or a market-based approach.

What is the Standard of Value in a Divorce Case?

Business valuators or other valuation experts or professionals must define a standard of value when preparing a business appraisal. A standard of value is the set of hypothetical conditions which will be used to value the business  the business. In business valuations for family law and divorce cases, there are generally two accepted standards for valuation : 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 business appraisers will apply discounts for various considerations including things such as a discount for lack of control (DLOC) or a  discount for lack of marketability (DLOM), when attempting to determine the value for minority interests  in a business.

The accurate meaning of fair value for a business generally depends on the individual case considerations. Fair value is similar to fair market value in some ways, but it generally does not involve the application of minority discounts. Fair value is ultimately determined by the court through a hearing or the agreement that the parties come to in a settlement or mediation. 

The two standards of valuation mentioned above can result in significantly different value determinations. In divorce case processes, it is important that business experts or business appraisers select the correct method of valuation  or their expert opinion may not be considered credible by the court.

Good will is another substantial consideration in business valuations. This is the expectations that customers will continue to support a business, generally based on customer loyalty, location, number and types of clients, revenue, reputation of business and owner, longevity of the business.

It is important that you work with a family law attorney who is knowledgeable and well versed in valuing business through divorce. At Pingel Family Law, we have decades of experience in addressing these complex property and valuation issues. Our attorneys are well versed in case law, the methods of valuation and in making sure that a knowledgeable and capable expert fairly and accurately values the business involved.

Double Dipping

A common issues or concern for a spouse when he or she owns the business being valued is whether “double dipping” is taking place in the asset division. This is the idea that the non-business owning spouse may be awarded the financial benefits of a business twice- once through an equitable distribution of the marital assets involved and a second time through income generated by the business, through an award of maintenance or child support payments. Often this is done through capitalizing the entity’s income over period using an expected rate of return with forecasted profitability for the future.  The argument would be that using this income stream to award the other spouse value as an asset and then using this same income stream to award the other spouse future monthly payments through a support obligation is unfair to the business owning spouse and represents double dipping. It is important that you have a legal advocate who can protect you against these concerns. When the income-generating spouse earns compensation above an anticipated market rate for his or her educational level, it is common that this becomes a concern in closely held businesses. Often, a business appraiser will attempt to make adjustments to normalize market-rate expected compensation and return the difference in the amounts to the company’s earnings. This typically allows for a higher business or company valuation however, if the business is valued at a higher level through this method and then the spouse’s compensation is also used at the higher level for maintenance or child support calculation purposes, likely, double dipping has occurred. 

Additionally, the business valuator’s knowledge and history is important as some businesses can have a sizeable swing in valuation numbers depending on how goodwill is used or calculated. Some business valuators do not place any value into the consideration of good will and some business valuators will consider it a particular entity’s largest asset. 

Preventative Measures

In family owned or closely held businesses, divorce can create a severe financial implication for each spouse, as well as having a potential substantial affect on the future profitability of the business being valued. A divorce often creates significant financial and emotional burdens on the spouse running the business and sometimes cash-flow or interruption of credit-worthiness issues are created for the spouse actively managing the business. These factors can adversely affect the spouse’s time and focus on the business, productivity, profitability and employee morale.  Often when spouses engage in a substantial disagreement on how to value or divide a business, this occurs due to a lack of zealous advocacy, experience from legal counsel and other legal advisors and a failure to provide each involved spouse with informed options, risks and benefits and ultimately, the legal advocacy and skill to help guide the parties to making informed decisions. 

In some circumstances, a shareholder agreement can help parties in a case minimize the impact of the divorce on the company or business by defining guidelines to follow in the event of a divorce. In some shareholder agreements, there are pre-defined steps or criteria for valuing each spouse’s interest in the company. In some cases, prenuptial agreements, postnuptial agreements or other contracts can help guide spouses and their legal advocates as to how the business assets should be fairly and accurately divided. Again, it is crucial to both parties in a divorce situation that they have knowledgeable and experienced legal counsel. Please schedule your consultation with Pingel Family Law today to help us help you analyze these crucial issues.

Preventative Measures

In family owned or closely held businesses, divorce can create a severe financial implication for each spouse, as well as having a potential substantial affect on the future profitability of the business being valued. A divorce often creates significant financial and emotional burdens on the spouse running the business and sometimes cash-flow or interruption of credit-worthiness issues are created for the spouse actively managing the business. These factors can adversely affect the spouse’s time and focus on the business, productivity, profitability and employee morale.  Often when spouses engage in a substantial disagreement on how to value or divide a business, this occurs due to a lack of zealous advocacy, experience from legal counsel and other legal advisors and a failure to provide each involved spouse with informed options, risks and benefits and ultimately, the legal advocacy and skill to help guide the parties to making informed decisions. 

In some circumstances, a shareholder agreement can help parties in a case minimize the impact of the divorce on the company or business by defining guidelines to follow in the event of a divorce. In some shareholder agreements, there are pre-defined steps or criteria for valuing each spouse’s interest in the company. In some cases, prenuptial agreements, postnuptial agreements or other contracts can help guide spouses and their legal advocates as to how the business assets should be fairly and accurately divided. Again, it is crucial to both parties in a divorce situation that they have knowledgeable and experienced legal counsel. Please schedule your consultation with Pingel Family Law today to help us help you analyze these crucial issues.

Forensic Evaluations and Fraud

The non-business owning spouse may be worried about the other spouse who controls the business hiding money or committing fraud. A business owner going through a divorce may attempt to transfer, hide or conceal assets, underreport revenue or assets or overreport or overstate expenses (to make the business appear less profitable than it actually is). If  you suspect (or the business valuator suspects this, it may require the joint efforts of  a forensic accountant or a business valuator that has this specialized expertise and knowledge). 

Are all assets of a business being considered?

Many business have intangible assets such as intellectual property. This can include such things as copyrights, trademarks, patents and other similar valuable items that need to be valued to get to a fair determination as to what a business is worth.

How should the business valuation be conducted during the divorce case process?  

The spouses have several options available to them:

The first option, which is the most dangerous and generally not recommended, is for the spouses to try and figure it out on their own or for one spouse to take the other spouse’s “word” for the valuation amount.

The second option is to hire a joint forensic accountant or expert valuator who will value the business. This is often a good option, but requires legal expertise in designing a process to make this valuation fair and collaborative with both spouses being able to give input as to information and assumptions used for valuation. 

The third option is for each spouse to hire his and her separate forensic accountant.

1. Trying to figure out the business' value on your own or taking your spouses word for the valuation:

In our opinion, without fail, this is a bad idea. The spouses will either undervalue or overvalue the company unless a spouse has specific business experience in business valuation and can clearly articulate the methods of valuation. 

2. Hiring a joint forensic accountant for the business valuation:

A joint forensic accountant or business valuator is one who both spouses jointly use and trust to provide an appropriate valuation and on whom both spouses agree to rely upon in negotiations that hopefully lead to a settlement. A joint forensic accountant, like any forensic accountant, does not provide legal advice but can be used to provide a value jointly relied upon by the spouses in valuing the business.

When spouses hire a joint forensic accountant to provide a business valuation, they also have the option to utilize separate forensic accountants to review the joint accountant's work and provide individual feedback and expertise about the valuation completed.

The benefit of hiring a joint forensic accountant is that it generally significantly reduces costs (i.e. the two spouses pay for one accountant, rather than two).

The downside to this method can be if one spouse disagrees with the joint appraisal. What happens if one spouse disagrees? The spouse may hire his or her individual  forensic accountant to review the joint accountant's work.

What happens if both spouses disagree? That means each spouse hires a new/individual forensic accountant and the parties have now paid three forensic accountants to conduct the business valuation.

There are different ways to agree on a joint forensic accountant for the business valuation

The spouses can agree informally, amongst themselves, sometimes this occurs before a divorce case is even filed or instituted.

The spouses can sign a contract with the joint evaluator  but not make the contract into a court order.

The spouses can appoint the evaluator as the court's expert through a an agreed upon court order.

Each of these options comes with some benefits and some risks. The pros and cons of each approach are highly customized and dependent on the individual needs and circumstances of your case. Scheduling a consultation with Pingel Family Law to further understand these options and to determine the best course of action for your individual case is essential.

3. Each spouse can hire his and her independent business valuator to perform a business valuation:

This is generally not a contentious or adversarial step, but simply viewed as a necessary step by legal professionals when required. The business appraisers each engage in their respective best efforts to determine a fair valuation for the business. 

Business valuations are both, an art and a science, and therefore professional opinions can sometimes disagree. When possible, the parties’ forensic accountants should communicate to try to come to some joint recommendations and a joint approach for valuation.

In those situations where the forensic accountants both have reasonable arguments in support of their valuation, the spouses, lawyers, and accountants can ideally collaborate to try to reach a compromise as to value that represents a fair outcome for both parties. 

Does your divorce involve a business valuation?

Pingel Family Law represents husbands and wives in both, Kansas and Missouri. Our family law firm works closely with many expert business valuators and respected forensic accountants. We have experience with divorces that involve a business. Contact us for your consultation today. We are dedicated to helping you find and start your new beginning.

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