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Know your (business’s) worth: When the valuation process and divorce proceedings converge

This year, nonprofit research and advocacy organization, Family Enterprise USA, in the first study of its kind published in 18 years, reported that family-owned businesses remain the country’s largest employer, supporting the livelihoods of more than 83 million people. Or, put another way, nearly 60% of the private sector workforce.

When all is harmonious in the personal and business lives that, by their nature, intersect, the business is a source of mutual pride and joy. But, when things go south in your relationship, the business can be yet another source of acrimony. Divorce is sufficiently difficult when it is the personal relationship breaking up. But when your partner is also involved in the business, and may have a stake in its ownership and operations, it is not “just” the marriage that is “breaking up.”

Know your (business’s) worth: Why it matters

At first blush, the valuation process goes hand-in-hand with the sales and acquisition process. You as a business owner need to know how much you can make, or you as an acquirer need to know if you’re being taken for a ride.

Yet, the power of the valuation goes far beyond the “obvious”; it can be a lifesaver when you’re staring down various sticky situations, especially divorce proceedings

Notably, it puts more than a number to the business; the process also zeroes in on the value of your spouse’s ownership during this transition in life and transition in business

Never assume that the last valuation you had done is relevant, and never assume that the labor and love you put into the business equates to its fair market value. It may have played a considerable factor in its viability through the years, but many quantifiable factors that fluctuate with industry and economic ebbs and flows help you approach a realistic and fair value.

Look at it this way; how different was the world a year ago, let alone five or 10 years ago? Both of these timeframes were before a pandemic, or took place as many industries were still recovering from the not-so-great recession.

Professional business valuations that are based on real data, not emotions or misperceptions, serve you well – they assure that you don’t settle for less than fair market value or that you don’t hand over an undue amount of equity while also grappling with increased costs (which may not have been taken into account when using yesterday’s information rather than today’s reality).

In fact, it has such multi-faceted power and benefits, particularly as we never know what tomorrow may bring, that a general best practice is to keep your valuation “fresh,” updating it annually.

Steps toward a reasonable valuation (and a successful settlement)

In a nutshell, valuations are calculated by totaling tangible assets, such as machinery and real estate, and intangible assets, such as Intellectual Property, against liabilities and debts outstanding.

There are several different methods that may be employed. So, again, these are generalizations. More on those methods later.

As part of the marital dissolution process, spouses generally must:

  • Identify assets

  • Value assets

  • Divide assets

Assets such as bank accounts are straightforward. Splitting assets within a private business if both you and your spouse have ownership stake, well, that’s more involved.

First, consider is the business interest a “marital asset”? Or, is it “separate property”? The answer to those questions depends on if the interest was owned before you tied the knot, and on what funds were used to acquire the business. Additionally, personal contributions to the business by you and your spouse, respectively, must be considered.

Second, each owners’ interest must be valued using a proven process. While the value of the business as a whole may be agreed-upon, the value of each party’s interest is often contentious.

As referenced earlier, there are generally three methods to determine the fair market value of a business interest:

  • Asset-based – The “going concern” asset-based method evaluates the company’s balance sheet, lists total assets, and subtracts total liabilities; “liquidation” asset-based approach pinpoints the net cash received after all assets are sold and liabilities are satisfied.

  • Market – Establishes value by comparing your business to similar ones that have been sold recently (akin to real estate comps in the housing market), and it’s an approach that requires a sufficient number of similar businesses as a point of reference

  • Income- or earnings-based – A nod to the business’s capacity to profit into the future, capitalizing past earnings normalizes previous income for unusual revenue and expenses, and multiplies the “normalized” cash flow by a capitalization factor; conversely, discounted future earnings produces an average for projected future earnings and divides this figure by the capitalization factor.

In summary, while the earning- or income-based value is most commonly used, it may not be the most appropriate or fairest way to determine value in divorce. There are no rules that say you can’t combine approaches. The method that is employed in partnership with your business valuation professional is as one-of-a-kind as your business, family, and team.

Ultimately, a judge may need to determine the most credible valuation. So, it pays to team up with experienced, accredited valuators.

And, even if the above considerations are resolved quickly and relatively easily, spouses must come to yet another agreement:

  • Are you buying your spouse out? Is he or she buying you out?

  • Are you selling the business?

  • Are you going to continue to share ownership?

Buy-outs are the most popular method; however, depending on the nature of your business, it may not be a feasible option. In professional services businesses, such as a legal or engineering firm, only the licensed spouse may own the business. So, this can be limiting.

If the buy-out isn’t viable, the most likely strategy would be to sell the business and split the proceeds. This process is common when addressing other types of assets, such as physical property.

Rarely, spouses continue as owners together after the divorce. Obviously, the ability to sustain the business in this way depends on how amicable the relationship is and the appetite you have for continuing a relationship with your ex in some way. Some spouses are even able to manage the business together jointly post-divorce or separation. Alternately, one spouse may remain more involved with the management while the other remains “hands-off,” receiving a percentage of future profits and, in turn, satisfying his or her share of the marital assets.

Of course, these common arrangements can be challenged by the likes of debts outstanding, third parties (agreements) and additional ownership considerations.

O’Donnell, Ficenec, Wills, & Ferdig has proudly served business owners in the metro area in good times and bad for more than 70 years. Our team includes CPAs who double as Accredited in Business Valuation®-designated professionals. The ABV® designation provides peace of mind that you’ll be able to resolve disputes successfully, fairly, and promptly.

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