When you file for divorce, you probably have a million different things running through your mind. You need to make sure that your children are taken care of. You need to figure out how spousal support will play into your situation. And, you need to consider how debt and assets will get divided among you and your spouse. If you or your spouse own a small business, this asset should get considered in divorce. But how will the court determine how to divide this asset? Which spouse is entitled to what when it comes to the business? These questions and others get answered through a process called valuation. The valuation of a small business in divorce is something that you should be familiar with. Whether you own the business or your spouse does, you need to know how it will get valued and what you can receive in divorce. This article will discuss several factors related to valuing a small business in order to give you the information that you need to succeed during this process.
1. Valuation Theory
Before we discuss valuation practice, it would help to have an understanding of the valuation theory behind it. The purpose of valuation is to determine the value of a small business. There are many reasons of valuing a small business, one of which is a divorce. Valuation of the business occurs in divorce to help the couple split this asset as they go their separate ways. When valuation gets used in a divorce, it draws on historical data to determine the business’ value. Any future earnings of the business that occur after the divorce takes place will not be divisible between the spouses in the state of Texas. In other words, future earnings remain with the business owners, partners, and shareholders.
The value of any asset, in this case, a small business, is measured by that asset’s market value. Market value refers to the amount of money that a buyer would pay to purchase the business. If the asset has no market value, the value gets determined by using another value system. Learn more about these forms of value below.
A. Market Value
Whenever possible, the value gets measured through market value. Market value refers to the amount that a buyer would pay for the small business. The Texas Supreme Court further defines market value by saying that the amount must get derived from a willing buyer and a willing seller. Both parties involved must be willing and able to buy or sell the property for the market value to stand.
Determining marketing value for the purpose of divorce is not always easy. This is because the valuation of a small business based on market value is often hypothetical. This makes market value differ from the actual value. In contrast, the actual value is only determined after negotiations between the buyer and the seller. When working in hypotheticals for the divorce, these negotiations don’t happen. So, the actual value is more difficult to determine, and the market value figure might not be accurate. Determining market value, therefore, relies on additional approaches, such as the market data approach, the cost approach, and the income approach.
B. Intrinsic Value
If market value cannot get determined, the court will use intrinsic value to establish the business’ value. Texas defined intrinsic value in Rosenfield v. White 267 S.W.29 596 as, “The true, inherent and essential value of a thing, not depending upon accident, place or person, but the same everywhere and to everyone.”
C. Value To The Owner
Value to the owner can also determine valuation in divorce, but again this only happens if market value cannot get determined. It refers to the intangible value of the business based on its:
- Work force.
- Operating assets.
- Organizational structure.
D. Book Value
Book value carries little weight in determining valuation. But, if no other type of value can get determined, book value can apply. So, it is still worthwhile to be familiar with this term. It refers to the sum of the asset or small business’ accounts.
2. Valuation Methods
In addition to the forms of value mentioned above, there are a few different valuation methods. These include:
- Adjusted net asset method.
- Rule of thumb methods.
- Excess earning method.
- Capitalization of earnings method.
- Discounted earning method.
- Market-based methods.
3. Valuing Your Small Business
Generally, in divorce, valuation of your business happens in court. This usually happens by a trial by experts. Some experts who might be involved in your case are those with the following credentials:
- Accredited In Business Valuation (ABV).
- Accredited Senior Appraiser (ASA).
- Certified Business Appraiser (CBA).
- Certified Valuation Analyst (CVA).
Make sure that those handling your case are properly qualified. This can make sure that your business gets valued correctly.
Also, you can present documenting evidence in court. Be careful when presenting this evidence in court. The other party in the divorce can use your evidence against you, so make sure that this won’t happen before you enter it into court. A lawyer can help you determine what type of evidence will help or hurt you in court. You can present the following documents as evidence:
- Original purchase documents.
- Personal property tax rendition records.
- Corporate balance sheets.
- Corporate minutes.
- Sales forecasts.
- Financial statements.
- Representation of values to third parties.
- Tax returns.
- Buy-sell agreements.
- Stock transfer ledgers.
- Partnership agreements.
- Previous litigation.
- Market studies.
- Loan applications.
- Trade association literature.
- Insurance policies.
- Business interruption.
- Underwriters’ reports.
- Equipment leases.
- Real estate leases.
- Real estate tax records.
- Record replacement insurance.
- Offers to sell or buy.
- Profit and loss statements.
4. Issues In Valuing A Small Business For Divorce
Valuing a business during a divorce is not always easy. There are a few different issues that you might face as you go through this process. Here, I’ll discuss some of the most common ones.
A. Transfer Restrictions
Many corporations have bylaws that restrict the transfer of interests or shares. In divorce, this can have implications for the spouse who is not involved in the business. One important question to ask in divorce is if these bylaws apply to the non-involved spouse or not. Both spouses should be aware of how these bylaws and transfer restrictions will impact the divorce. Every situation differs based on the small business’ specific agreements and bylaws. You should consider whether the non-involved spouse signed agreements that allow restrictions on transfers. Also, consider the nature of any agreements signed.
B. Buy-Sell Agreements
Many partnerships also contain buy-sell agreements. These agreements are between shareholders and partners. They are meant to protect these parties and make sure that the business is well run. These agreements also generally include information regarding the buying and selling of stock or interest.
These agreements can affect divorce. In most cases, these agreements get triggered by divorce. If the non-involved spouse signed the agreement, they have a say in these agreements. Texas caselaw that a buy-sell agreement defining the value of the business’s interest limits the value of the interest that may be awarded in the divorce.