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Business valuation in divorce Tricky enough in the best of circumstances, valuing a business becomes even tougher when the owners’ marriage is going south Establishing business value for the purposes of marital dissolution is one of the more common reasons for using a business valuation specialist (or "analyst"). Perhaps more than in any other scenario, divorce-related valuation requires that the analyst bring to bear all of his analytical and investigative skills. There are at least three reasons for this. First, almost without fail, the non-operating spouse will contend that the couple’s company is a haven for hidden assets stashed by the operating spouse. Second, to refute or substantiate that contention, the analyst will have to review thoroughly the company’s compiled financial statements. If the reports are not recent, or if the bottom line is skewed because the couple ran personal expenses through their business, he cannot produce a reliable valuation without reviewing the underlying transactions. Third, the peculiar nature of divorce often makes it difficult to establish and remain faithful to an effective valuation date. As a result, the analyst may need to be more active than normal in producing financial statements that accurately reflect the company’s assets, operations and financial health. He also will need to understand how judicial behavior and combativeness between the parties make business valuation in divorce different from its application to other contexts. Discovery. The reliability of any business valuation depends primarily on the accuracy of the information on which it is based, but accurate information on a business owned by a divorcing couple can be hard to come by — especially for the non-operating spouse. Consequently, the attorney for the non-operating spouse may need to rely on the valuation expert for guidance on what types of information to request or subpoena. The valuation expert should provide a detailed, specific list of documents that will be needed, plus a "blanket" request for all documents that may help determine company value. He should also provide the attorney with a list of questions to be asked of the business’s management personnel via interrogatory or deposition. Date of valuation. Three basic valuation dates may be pertinent to a divorce proceeding:
The date closest to trial or settlement generally applies to more complex companies whose value depends on a variety of factors: workforce, location, underlying asset values, etc. The date of separation is more likely to apply to small or simple businesses whose revenues are directly attributable to the involved spouse. Examples include professional practices, skilled trades, and service businesses that are inseparable from the owner. (Using this valuation date assumes that the parties can agree on the date that they separated.) A date of marriage valuation is applicable where one of the parties owned the business before the marriage began, and his or her spouse may be entitled only to half of the net growth that occurred while they were married. In such cases, the increase in value from the date of marriage to either the date of separation or date of trial will need to be calculated by appraising the business as of the starting and ending dates. Various allocation formulas can then be applied to determine the marital portion of the business to be divided. Standard of value. While fair market value is appropriate for most valuations, it isn’t always applicable in divorce. For example, valuation of non-marketable professional goodwill or of licenses or educational degrees can’t be based on fair market value because such assets can’t be sold in any marketplace. In such cases, the intrinsic value standard — i.e., what an asset is deemed to be worth, notwithstanding its value on the market — may be more appropriate. Agreed value, established in a buy-sell agreement, is another standard of value, but it isn’t necessarily binding in divorce. Courts have been known to ignore an agreed value if the intrinsic value of retaining a company’s stock may be greater than the buy-sell value. Methods of valuation. While the method of discounting future cash flows is generally the most comprehensive, and thus most widely used, approach to determining FMV, it is not the method of choice in divorce. The reason: Many state courts have held that a business’s value resulting from the efforts of the operating spouse after separation are not marital property: The most common method used in divorce is the capitalization of earnings method, which considers only a company’s history, not its future performance. Other popular methods include prior sales, capitalization of cash flow, adjusted book value, excess earnings, revenue multiples, book value multiples, buy-sell agreement formulas, and sales of comparable businesses. Determining the marital allocation. There are two primary ways to allocate an increase in company value during the marriage: the Periera method and the Van Camp method. Periera treats the value as of the date of marriage as an investment that should generate an appropriate rate of return during the marriage. Thus, the value of the marital property would be equal to its value on the date of separation (or trial/settlement), less its value on the date of marriage, plus the expected normal yearly returns during the marriage. Van Camp considers the value of services provided to the business by each spouse during the term of the marriage and compares that value to the compensation each received. If either is found to have been underpaid, the underpayment is deducted from the value of the marital portion (including a return on the underpayment to the date of separation or trial/settlement). Predictably, spouses who are not involved in the business prefer Periera, while operating spouses like Van Camp. While the two methods can produce similar values, they often give sharply different allocations between marital and separate property values. To resolve a large conflict between the two allocation methods, valuation analysts often use a third approach — the Todd method — which seeks to achieve a value that reflects both the return on investment and the value of any undercompensation. Conclusion. Business valuation is a science unto itself and is often unforgiving of attempts by non-specialists to produce values based on instinct or generic formulas. Further, valuation in marital dissolution is distinct from valuation for other purposes. Recognizing the unique aspects of divorce is crucial to achieving an accurate, defensible valuation for companies whose owners are going their separate ways. Based in Mesa, Arizona, and serving closely held businesses in the East Valley, the Phoenix area and throughout Arizona, Schmidt Westergard & Company, PLLC, is an independent full-service tax, audit, accounting and business advisory firm focusing on the middle market. |
