Valuing Businesses During a Divorce

Businesses must be valued in a divorce because they are rarely sold

The construction of marital estates necessitates the inclusion of businesses run by divorcing parties. And although it is often threatened by business owners, it is highly unusual that a business is sold to effect a marital estate division. Consequently, it is necessary to value a business owned by a couple so that its relative worth can be recognized in the marital estate.

The valuing process is similar to other assets

The valuation techniques applied to businesses can be similar to those applied to other assets. That is, if the parties are knowledgeable, they can agree on a value. The parties can also refer to trade publications or Internet sites to determine values that are equitable. And finally, the value of the business can be determined by the engagement of an expert.

Typically, however, the parties are not knowledgeable about what affects the value of a business and, consequently, cannot fairly assess the value of their operation. In addition, reference to generally available information on businesses or professional practices may generate only “rules of thumb” which can yield suspect results when applied to the business in question. This makes the reference to a qualified business valuator the safest course of action in most cases. However, the following key factors can help assess the necessity of a business appraisal.

All businesses have a minimum value

The minimum value of businesses is usually the fair market value of its assets less its liabilities. This is essentially whatever the assets of the business could be sold for minus everything that the business owes to anyone. The worth of a large proportion of small businesses is this minimum amount.

Most small businesses are jobs

The majority of small businesses are the equivalent of holding employment situations. That is, the owners earn amounts similar to what they would be paid if they worked for someone else. The only difference in these situations is that the business owner possesses the assets and incurs the liabilities necessary to run the business. Normally, a business owner has to make more money than he or she would earn in an equivalent employment situation in order for the business to be worth more than the minimum value.

The income reported by small businesses is often understated

For numerous reasons, the income reported by small businesses may not reflect the true economic income of the enterprise. Therefore it is important to take steps to ensure that the income of the operation is stated as fairly as possible. Steps can include agreement of the parties on the income of the business, mutual review by the parties of the books and records of the company, or referral to an expert for adjustment.

Steps to assess the need for the involvement of an expert

The following steps help determine whether an expert is needed to value a business.

(1) Determine the economic income of the business. This figure is not only necessary to value a business, but for the determination of child support and alimony. If the parties are knowledgeable about the operation, then an agreement as to economic income may be acceptable. If one of the parties is not knowledgeable, but possesses financial ability, a review of the company records by that party may provide the knowledge necessary to agree on income. If one of the parties is not knowledgeable and lacks the resources to become so, then the services of a financial expert should be retained.

(2) Determine the minimum value of the business. First, the value of all of the assets of the company is determined. The fair market values of the assets of the business are determined like any other asset in the marital estate. That is, the parties can agree on a value, they can seek publicly available information, or they can hire an appraiser. Second, the amounts the business owes are collected. The total value of all of the liabilities is subtracted from the value of all of the assets. The difference is the minimum value of the business.

(3) Compare the earnings of the business owner to equivalent salaried positions. Average earnings for various types of jobs and professions are readily available. For example, the U.S. Department of Labor Bureau, Labor Statistics (http://www.bls.gov) compiles these types of averages on a state-specific basis. Comparison of these averages to the earnings of a business (after adjustment) may indicate the value of a business or whether an expert should be involved. It is likely that businesses providing income for the owner that is similar to what the owner could earn as an employee have only minimum value. It is possible that businesses earning significantly more than salaried positions will have a value that exceeds the minimum value of the business. A business that makes more than a salaried position might have a value higher than just the assets of the business to a prospective purchaser. Referring these businesses to an expert should be considered.

Referral to an expert for valuation

There are essentially two schools of thought when it comes to valuing businesses for divorce purposes. Some jurisdictions hold that the value of a business should be what it is worth to someone other than the owner, and others hold that it should be what it is worth to the owner. Sometimes this difference is referred to as fair market value versus fair value. The application of these different standards of value can cause significant differences in business value.

Fair market value has been variously defined, but it is usually considered to be the price a hypothetical willing buyer would pay a willing seller for a business. The concept of fair value is highly dependent on context and can be highly subjective. For example, some states have developed fair value standards to be used in minority stockholder disputes. These standards may or may not be the same standards that are applied in divorce. In addition, the standards of value that are applied for divorce may vary within a state from county to county or even from judge to judge. To further confuse the issue, judges (and, unfortunately, some experts) routinely state that a value is fair market value when it is really fair value.