How to Value a Business for Divorce
A significant part of going through a divorce is valuing assets. Massachusetts is an equitable distribution state, meaning that assets get divided according to what is fair. Fair, however, is not necessarily equal, and why each asset must be valued individually during a divorce. This task can be accomplished with relative ease for certain assets, such as a house or car. For other assets, such as a business, the value can be far trickier to determine.
Most businesses lack a well-defined market value, or one that is straightforward and obvious, which can make finding that value a point of contention during a divorce. The good news is divorcing business owners or those married to a business owner have the option of hiring a professional, such as a divorce attorney versed in business valuation, and, if necessary, alongside them, a business appraiser they consult with for added insight to help value their business.
Although some individuals choose to value their business themselves, the process can become complicated fast. This leaves room for error or the possibility that a deal could have been better with the guidance of a business valuation lawyer.
Regardless of the route you choose to value a business for divorce, it is necessary to understand the business valuation process first. If you are divorcing in Massachusetts and are just beginning to think about how your business will factor into your divorce, including what your business may be worth, this is what you should know.
How is the value of a business determined during a divorce?
Determining the value of a business is not too different from valuing other assets; the critical difference is that businesses, even small businesses, have many moving parts. Therefore, it is necessary to ensure that each part is accounted for. For starters, this means evaluating the business’s assets and liabilities.
The property belonging to a business, both tangible and intangible, constitutes a business’s assets. Tangible assets are easier to account for and include mechanical equipment, inventory, savings, and other monetary funds. Intangible assets can be anything from patents to relationships with clients, which can be more challenging to quantify. A simple way to think about assets is that they have value and work to the company’s benefit, now and in the future.
On the other side of the ledger are a business’s liabilities. The opposite of what earns a business money is what costs it money. Liabilities can include employee wages, loans, and other debts the business may owe. Business valuation requires adding up all of its assets and subtracting its liabilities.
Another perspective on the value of a business entails calculating the business’s income. To calculate a business’s net profit, add up its profits and subtract its costs. Profits are usually determined by the total amount of money a business receives for selling a good or service, and investments and sales from business assets. Costs include expenditures such as employee wages, equipment, materials needed to create a good, and more. Income is typically calculated over specific periods, such as a quarter or a year.
The most common approaches business valuation lawyers and business appraisers use to value a business for divorce are the market approach, the income approach, and the asset approach.
The market approach uses comparisons of similar businesses that have been sold in the near past. If the business were on the market today and someone bought it, the market value would be the price that buyer would pay.
On the other hand, the income approach focuses the earning potential of a business. The conventional approach is to consider income over the past few years and to use those numbers and some other factors to project income in the future. The experts then use those numbers and some other factors to calculate its present value.
And finally, the asset approach involves a calculation of the value of the business’s assets: property, equipment, cash, and other items of value. It is most commonly used when the value of the assets exceeds any value generated by the other two approaches. A good example is someone who runs a one-person operation and has valuable pieces of equipment.
How is the value of a business divided in a divorce?
During a divorce, there are several other factors to consider beyond the value of the business itself. For instance, how much of the business is the spouse entitled to, if anything? The answer to this question depends on whether the business interest was acquired during or before the marriage and if it was acquired using separate or joint funds, among other factors.
Depending on the length of the marriage and other factors, if the business interest was acquired before the marriage or with separate funds, then the owning spouse may receive credit for that. However, if the business was acquired using joint funds, if the non-owning spouse contributed to the business with capital or by working there, or generally, if there were contributions by either party during the marriage, then the non-owner spouse may be entitled to a percentage of the business.
After determining that each spouse has a stake in the business, how will the percentage be calculated?
In other words, what will the size of that portion be? Now is the point where business valuation comes in. Due to the complex nature of business valuation and how it involves speculation, there still remain unknowns.
For instance, how can anyone ensure the future interest in a business is accurate? The business could fail in the future due to outside forces, or it can take off and become significantly more valuable for the same reason. Because there are no guarantees as to a business’s future value, spouses must find a valuation each can agree to in the present. And if they cannot agree, a mediator or judge decides. A lawyer who is versed in valuing businesses for divorce will understand these uncertainties to provide the clearest outlook possible.
Jurisdiction can impact the valuation of a business during a divorce, too. Each state has its own laws, so the way businesses are valued varies. In Massachusetts, the income and market approaches remain the generally preferred standards used to value a business, especially higher-value ones. However, in some circumstances, particularly where the other valuations don’t apply, asset valuation may be preferable.
How do I protect my business in a divorce?
Divorce can have a significant and adverse impact on a business in numerous ways. Most obvious is that having to open a business’s books during a business valuation can eat up time and resources. The emotional havoc a divorce can wreak can do the same, not to mention, cause distraction.
While business valuation is often not something people give too much thought to before marriage, when a marriage is good, or even when divorce is imminent, it can be worth taking preventative measures to protect a business beforehand. Businesses are particularly at risk of suffering from a divorce when jointly owned.
Fortunately, there are legal documents, such as shareholder agreements, prenuptial agreements, and postnuptial agreements, that can help streamline business valuation in the event of a divorce. Spouses, for example, can use a shareholder agreement to determine guidelines on how to divide the business under various circumstances, including during a divorce. A shareholder agreement can help value the business interest of each spouse, as well as grant ownership to a spouse. A prenuptial agreement and postnuptial agreement could also outline how to divide a business in a divorce.
Ideally, these agreements should be drafted at the start of a business partnership. Then, they should be regularly updated as the business grows or new circumstances arise so that each spouse remains protected, can make well-informed and fair decisions, and, most importantly, do not get blindsided by a divorce and the complications that can come with it.
Another concern during the division of a business during divorce is known as “double-dipping.” With double-dipping, the same income stream gets counted twice. The first time happens when a spouse receives a property interest based on a business’s future earning potential.
The second time occurs when the spouse gets an alimony award or child support award based on that same income source. In other words, a single asset, the business, is used to determine two different sources of income. However, judges generally avoid double dipping whenever possible by trying to separate the income used for purposes of asset division from that used to calculate support.
How can I prevent fraud during a business valuation for divorce?
Finally, and however unfortunate, in an attempt to protect finances during a divorce, some business-owning spouses may feel tempted to engage in practices they may or may not be aware of constitutes fraud. Fraud can occur in various ways, such as hiding business assets and revenue and over-emphasizing business expenditures.
If fraudulent behavior is suspected, the non-owning spouse may need the help of a forensic accountant to work with the business appraiser, so they can act accordingly to protect the non-owning spouse’s interest. It is important to note that fraud is punishable by law and can come with a cost far exceeding any associated with divorce.
Protect your business by hiring a Massachusetts divorce lawyer knowledgeable about business valuation during a divorce.
At Farias Family Law, we know how important it is to have financial security after divorce. Regardless of your role in a business, as a business owner or the person married to one, our team of Massachusetts divorce and family lawyers are prepared to advocate on your behalf. We can help ensure the business in question is valued correctly, and your interests are protected.
In addition to our skilled divorce attorneys, we have business appraisers and forensic accounts we consult with regularly who are ready and eager to support you and your case. Contact us at our Easton or Fall River offices today.