During your divorce proceedings, most of your property and debts will be divided among you and your spouse through a process called “equitable distribution.” To start this process, the court must categorize each asset and liability as either martial or separate property. Then the court will value the property based upon the fair market value at the date of separation.  For many items, this determination may be fairly simple; however, when considering a business entity, it may be significantly more difficult.

Separate v. Marital Property

When determining whether your business is considered separate or martial property, there are several factors that should be considered. The court will look at the date of the marriage and the date you or your spouse acquired the business interest. The court will also look at the source of the funds used to acquire that business interest. Additionally, the court will consider any extra contributions, either financial or labor-related, to the business during the marriage. If the business was acquired during your marriage, with joint funds, it is typically considered marital property. Marital property should be split between the spouses equally. If the business was acquired before the marriage, or with separate funds, it is separate property. It is also important to remember that, in certain situations, a business owned prior to the marriage may be considered marital property.

Difficulty in Valuing Business Interests

Valuing your business can be exceedingly difficult. For some small businesses, it may be easier for spouses to agree. However, many businesses have various assets and liabilities that range from little to significant value. For instance, your business may contain equipment (like cash registers and computers), inventory, accounts, pending profits, and outstanding debts. Even if we could easily value these items, many business owners only own a percentage of the whole company.

Methods for valuing a Business Interest

There are three methods for valuing a business interest: the asset approach, the market approach, and the income approach.

The asset approach is a very basic form of valuation. The value of the interest is simply ALL ASSETS minus ALL LIABILITIES.  These assets include tangible items, such as computers and inventory, and intangible items, such as patents and accounts receivables. While the formula for the asset approach is straightforward, appraising various assets can be difficult. The value of many assets depends on age, market demand, and depreciation, among other factors. Likewise, there may be unknown or unrecorded liabilities that are hard to consider in the formula. This method is typically reserved for small businesses or businesses that can be easily appraised.

The market approach utilizes the value of similar situated businesses in the market to value the business in question. An appraiser can look at a business similar in type, size, and location that has been recently sold and use that price to determine the value of the business interest.

The most commonly used method of valuation is the income approach. This requires statistics and data over the life of the business to predict future income and losses. Appraisers utilize specific formulas that consider risk and benefits to set a value.

Who appraises a business interest?

The appraiser of a business interest depends upon the situation. In certain cases, such as a small business, the parties may agree upon a value. Conversely, some cases require the use of experts to value the business interest. These experts are certified in their field, either as an appraiser or an accountant.  Many attorneys have a number of experts ready for just these situations. Even then, many times litigation will ensue into a “battle of the experts.” This happens when each party’s expert disagrees and the court must settle the dispute. The costs of this dispute, including significant legal fees, lead many parties to negotiate an amount between the experts’ valuations.