Whether a couple’s divorce has been amicable or contentious, it can still be a challenge to divide assets (and liabilities) between the two parties. The court must classify assets as either marital or nonmarital, place a value on them and then distribute them between the spouses. The challenge comes in both classifying assets and correctly valuing them.
If you are a business owner and are going through a divorce, this is what you need to know about valuing your company.
Marital vs. Nonmarital Assets
Assets acquired during a marriage, using joint funds, are considered marital assets. Those acquired before the marriage and acquired with separate funds are considered nonmarital assets. This means your business may be classified as either one depending on when and how it was founded or acquired. However, be aware that if your business is considered a nonmarital asset yet it grew or increased in value during your marriage, that increase in value could be considered a marital asset and subject to division.
Another big factor to consider is goodwill, which comes in three types: entity, personal and nontransferable. Entity goodwill consists of factors such as the company’s name (i.e., its inherent value in the market), its location and its trademarks and patents. Personal goodwill includes the business owner’s personal relationships, customer relationships and specialized knowledge about the business or industry — basically, anything that may be transitioned to another person. Nontransferable personal goodwill includes skills such as those a doctor uses to practice, which cannot be passed on to another.
In divorce, it’s very important to distinguish between personal and entity goodwill and then classify what is and is not part of the marital assets. This can be a challenging process, and lawyers on both sides often provide persuasive arguments in favor of or against a single element of goodwill. Click here to read more about how to determine personal goodwill in a commercial business.
Valuing Your Business
When an asset in question is a business, any portion determined to be a marital asset needs to be valued. Hiring a specialist with the appropriate credentials will help you avoid a Daubert challenge. To determine the included fair market value, you should engage a specialist in business valuation. Specialists include a certified public accountant (CPA) accredited in business valuations (ABV), a certified business appraiser (CBA) or an accredited senior appraiser (ASA). They can help you determine what needs to be valued and the interest held. They will also work with the attorneys and court to determine the as of date of the valuation.
The following three approaches are commonly used to value a business interest.
1. Asset Approach
The asset approach calculates value by determining the fair market value of tangible and intangible assets minus liabilities. Tangible assets include infrastructure, inventory and anything related to the business that you can touch, while intangible assets are patents, trade secrets and other assets that are not physical objects.
If you have a minority interest or a profitable operating business, this approach would typically not be used. It’s used more for businesses without profitable income or when fixed assets are a main part of the business.
2. The Income Approach
The income approach is based on the present worth of future economic benefits. The appraiser will apply selected discounted capitalization rates to expected cash flow and profits and thereby calculate the business’s value. This method considers future benefits as well as the rate of risk or return.
At Wipfli, we look at business cycles and five-year histories to help look forward, but if the past five years are not typically representative of the business’s future, then using other projection methods are necessary.
3. The Market Approach
The market approach determines the value of a business by comparing it to similar public companies or similar businesses that have sold. Basically, think of how an appraiser valuing a house looks at comparable homes in a neighborhood to help come up with its value.
The Value of an Appraiser
What about a difference of opinion? In divorce, it certainly happens often enough!
If the two parties in the divorce have different opinions on the business’s fair market value, it typically progresses to fair market value depositions. When you engage a specialist in business valuation, you gain a resource to help you not only prepare the valuation and provide an accurate fair market value but also provide expert testimony in court.
There is a lot at stake for business owners going through a divorce. If you have questions about classifying assets, determining goodwill or establishing value, contact a Wipfli valuation specialist.