If you’re a professional with your own practice – whether as a partner, a shareholder, or owner of a private practice – chances are that you’ve taken the necessary and essential steps to set the practice up in the most advantageous way, and in a way that will ideally protect you from liability, by consulting attorneys and accountants who specialize in those matters. You may have even thought ahead and considered the potential effects that a divorce might have upon your practice by entering into a prenuptial agreement or using another pre-planning device – but often, this isn’t the case.
The truth of the matter is that most people, when they first say, “I do,” intend marriage to be forever – and that’s understandable. It’s hard to imagine a relationship falling apart as it’s just beginning. For that reason, many people often don’t think ahead about the possibility of divorce, or how to protect your assets if it does happen. That failure isn’t a shortcoming – it’s not anyone’s fault. It’s just human nature.
If you find yourself in this situation – owning your own practice and suddenly facing a divorce, it’s also human nature to panic – but try not to. Don’t rush to liquidate your assets, or make sudden and abrupt decisions that are outside your normal course of business. Doing so will not only raise red flags for your soon-to-be ex-spouse and his or her attorney – it might also cause you to be accused of dissipating the marital assets, which is essentially a charge of taking assets from the marital estate for the sole benefit of one partner, and to the detriment of the other. This is not to mention that it’s also a good way to lose credibility with the judge in your divorce case – and that’s certainly not something you want.
In the long run, acting rashly without thinking through the consequences of your actions rarely pays off – and it is no different in a divorce. Instead, if you have your own practice and you find yourself facing divorce, the best thing to do is to consult with your divorce attorney and other necessary professionals who can help you come up with a sound legal strategy and appropriate course of actions – both to preserve your assets and retain the respect of the other parties and the court during the divorce process.
With that said, it can be helpful to go into the divorce process with a general understanding of how courts handle the division of professional practices, and what matters you might want to consider before you get there.
Valuing Your Professional Practice
Valuing your professional practice correctly will be one of the single most important aspects of ensuring that you are ultimately satisfied with what happens to your practice as a result of your divorce. It’s important to realize that when a professional practice is valued as part of a divorce, the method used to value the practice may be different than in other situations. Certainly, everyone’s situation is unique, and the most important step to take before moving forward with any valuation of your practice is to consult with your attorney and other qualified professionals. With that said, however, in a general sense valuing a practice will consist of the following steps:
- Determine the Standard of Value to be Used: There are few standards of valuing professional practices during a divorce that are generally accepted, although the method most favored by the courts is the fair market value. Fair market value is generally defined as the price that a willing buyer would pay to buy the asset from a willing seller on the open market. During a divorce, the court must find the current “net fair market value” of the asset in question – meaning the fair market value is reduced by the value of any liens or other debts that might encumber the business as of the date of valuation. Fair market value will also include tangible assets of the business, as well as accounts receivable, and sometimes even contingency fees for work performed during the marriage. Retirement accounts, including accounts like 401k accounts, IRA, and other employment-related pension accounts are also valued and divided. The fair market value method of valuing a professional practice is generally the most favored method by the courts.
There are other methods of valuing a professional practice that are less favored than the fair market value method, but that may occasionally be used depending upon the circumstances, including:
- Liquidation value: Liquidation value is the amount that the owner would receive if that owner were forced to sell the asset on the date of its valuation. Liquidation value generally assumes a forced sale and usually yields a lower value than a fair market valuation will. As a result, courts often reject liquidation value as the standard of value in a divorce.
- Going concern value: This is a broad term that looks to the value of a business as an ongoing and functioning concern. This method of valuation can comprise several different standards, but it rejects liquidation or book value methods.
- Original cost value: Original cost value is exactly that – the original purchase cost or start-up cost of the business in question. As most professional practices increase in value after the initial necessary assets are acquired, this method of valuation is usually not utilized during the divorce process.
- Book value: Book value us the value that is arrived at by adding all of the practice’s assets and deducting all of its liabilities. This method of valuation is also generally disfavored by courts as it is more easily subject to manipulation than other methods of valuation.
- Appraised value: This is, as it sounds, the value determined by bringing in a qualified, credentialed appraiser to professional assess the assets and debts of the practice and offer a professional opinion as to its value.
- Determine the Method of Valuation: The goal of valuation is to reach a determination of the practice’s current “fair market value” – but typically, courts do not require any one particular method of arriving at that determination. Two of the most common methods used to value professional practices include the total value method and revenue ruling method. Both of these methods involve adding the value of the physical assets and the accounts receivable and subtracting any liabilities. They also require valuing any goodwill as part of the practice’s value.
Ultimately, regardless of the valuation standard and method selected, the most important witness in any divorce case when it comes to dividing a private practice will be an expert who is professionally trained to value the practice, and who can clearly and articulately state the basis for that valuation.
Valuing Goodwill
No matter which standard and method is used to value the practice, it’s also essential to note that under any method utilized, the value of any divisible goodwill the practice has will also be included. While understanding goodwill from a legal sense can be somewhat complex, generally, business goodwill is the intangible value that is associated with the business and is considered to be part of the business’s value. Goodwill may be based on any number of things – the company’s reputation, its success, its customer base, and any number of other factors. Generally, it’s the standing and reputation that a particular professional practice has in the community, and how that reputation enhances the practice’s value.
Understandably, coming to a determination or a dollar figure on the amount of goodwill that any particular professional practice has isn’t always easy. Generally, in North Carolina, valuing goodwill is accomplished by using several methods, including:
- Capitalization of excess earnings: In this approach, the difference between the earnings of the professional practice in question and an “average” professional practice will be calculated, and the difference will then be capitalized (typically multiplied by a factor of between one and five, depending upon various circumstances). This is the most generally accepted method of valuing divisible goodwill.
- Subjective estimation: On more rare occasions, some courts will accept subjective estimates made by expert witnesses when those estimates are based on factors like the owner’s age, health, success, earning capability, reputation in the community and other similar factors.
- Comparable sales: Under this method, the goodwill of the practice will be valued by reviewing sales of similar businesses in the same area and of the same type at the time of the valuation. Goodwill is then determined by subtracting the total sale price of those comparable sales from the total value of the tangible assets.
Regardless of which method is ultimately used, the important thing to remember about goodwill is that if goodwill can be readily converted into a cash equivalent, then it is generally considered part of the practice, and thus is marital property that can be valued and divided. In other cases, where the goodwill is largely dependent upon one particular professional – for example, a doctor or a lawyer with a solo practice, the question is often raised as to whether the goodwill can be distinguished at all from the person, and if not, if it is divisible property. Though this type of goodwill can often be far more difficult to value as it is dependent solely upon the reputation and personality of a single individual, North Carolina courts have still generally held that this type of goodwill is still considered of value to the marital estate’s divisible property.
Dividing the Practice
It is important to realize, as you contemplate your wishes and goals for your professional practice, that courts will rarely divide a practice so that both spouses remain as owners of or partners in the practice after the divorce. First and foremost, it’s simply not wise to have ex-spouses remain financially and professionally entangled in the manner that owning and running a professional practice together would require. Secondly, there are state laws that often serve to prevent a non-professional from having an ownership share in any professional practice for which they are not licensed. So if a court is deciding the matter, jointly owning and running a practice following a divorce is generally not an option.
It’s also helpful to know that in North Carolina, courts will not typically order a practice to be sold with the proceeds being divided between the parties. As we have noted, in North Carolina, the goodwill associated with a business enhances its value and as a result, if a sale were forced, the parties might lose a great amount of that value. For this reason, among others, forcing a sale is not preferable or favored.
Typically, what courts will do if a professional practice must be valued and divided is to award the professional practice to the spouse who owns and runs it, and to require that spouse to pay the non-owning spouse a monetary amount equaling that spouse’s share. In some cases, the non-owning spouse will receive an award of non-monetary marital property (for example the marital home or other heirlooms and personal property) in an amount equal to the owning spouse’s share of the business.
Often, we are asked – what if the professional practice is the primary asset of the marriage, and there is not enough property available to be awarded the non-owner spouse to offset its value? It’s a reasonable question. In that event, the court may order a monetary award, to be paid by the owner spouse to the non-owner spouse, to be paid off as soon as practicable.
Ultimately, regardless of whether a court orders a monetary award or a property offset to the non-owner spouse, it is important to note that there should be no negative tax consequences for the receiving spouse. The Internal Revenue Code provides that when property is transferred between a husband or wife, or between a former husband and wife as a result of a divorce, the transaction is considered non-taxable. The recipient of the property simply assumes the existing adjusted basis of the property, and will, in the future, have responsibility for any capital gains tax if there is later a taxable sale of the property.
The Law Office of Dustin McCrary – Here for You
We hope that the foregoing information about how courts might address your professional practice during the divorce process was informative, and will be helpful to you as you move forward. Of course, as with any divorce process, it bears repeating that it is not always necessary to involve the court in the resolution of your issues. When it comes to dividing your professional practice, and any number of other issues that will arise in your divorce, ultimately you and your spouse have the freedom to decide those issues for yourself first. Before seeking involvement of the court, it is always wise and preferable to attempt to address the various issues between you together, in a cooperative way. Doing so often enables you to arrive at resolutions that are preferable and more satisfactory to everyone involved in the long run.
If you are a professional and you have built a practice that you’re proud of, and depend upon for your livelihood, it only makes sense that you want to protect it. At The Law Office of Dustin McCrary, we understand that, and just as importantly, we understand the necessary legal strategies and steps to take to help you do exactly that. We would be honored to have the privilege to assist you with protecting your professional practice, and with every other aspect of the divorce process. Give us a call any time – we look forward to helping you soon.