Valuation of Closely Held Businesses in Divorce Proceedings
Generally, divorce cases involving thorny property issues can be complicated to resolve. This especially is true when the marital estate includes a closely-held business. A closely-held business usually presents one of two scenarios in the divorce context. The business may be tied to one spouse who is responsible for the business’s success. Distribution of the business to one spouse often creates asset allocation and business valuation issues. It presents the problem of valuing the business and structuring the parties’ assets and liabilities in order to provide the other spouse with a comparably valued property distribution. If the business depends on the operating spouse’s good will and management, which many closely-held businesses do, then the true value can suffer under the emotional stress common in divorce even if the business is distributed to the key-person spouse. A business having one value when operated by the key-person spouse can have a far different value when distributed to the non-operating spouse.
Division by Court
The other scenario is that the parties agree, or are forced by circumstances, to sell the business and distribute the proceeds according to the court’s division order. The sale price fixes the value, but selling a closely-held business for its fair value can take a long time. That delay can stall closure of the divorce case and can result in a fire-sale situation with a corresponding effect on the sale price. The alternative of partitioning the business as a going concern into undivided interests raises the issue that the former spouses will try to manage the business together. That can be impossible if the divorce is acrimonious, and the business ties can deter the spouses from moving on with their post-divorce lives. A thriving and profitable business can ease the situation, but a struggling or declining business can be a burden to a divorce involving spouses of modest means.
A closely-held business involved in divorce proceedings eventually will require a valuation by a professional appraiser. The appraiser should have an in-depth knowledge of business valuation and should have good judgment in order to conduct a fair and accurate valuation. Above all, the appraiser should be impartial and not aligned with either spouse. Particularly in pure community property states, closely-held businesses can present difficult commingling and tracing issues. The appraiser may be called upon to make valuations as part of the asset tracing process, which requires impartiality.
Methods for valuing businesses fall under the following approaches:
- Comparable sales approach. This approach compares the business with a comparable business in the area that was sold recently. In theory, the comparable sale should indicate value, but comparables can be rare in less populated areas. It also can be difficult to measure the effect that losing the key-person can have on the value of closely-held businesses.
- Income statement approach. This approach considers the capital that is invested, cash flow involved, profit and losses, and debt load. Of course, this depends on accurate and true accounting. Odd, aggressive, or non-GAAP accounting can distort income sheet-based valuation considerably. As with comparables, past income statement activity may not predict the effect that loss of the key-person can have on the market’s perception of value.
- Balance sheet approach. This approach considers all the assets and liabilities of the business. As with the income statement approach, this requires that the owner(s) used accurate and honest accounting for the business.
An appraiser might use one approach or a combination of approaches in valuing a closely-held business. Apart from the above approaches, other factors to be considered in valuing a closely-held business include whether the key-person spouse will remain associated with the business in some capacity after the sale, when in the business cycle the sale must occur, and trends in the demographics that affect the business.
The contents of this website do not constitute legal advice, and do not establish an attorney-client relationship. Representative case results are provided as examples only, and do not guarantee or imply the same or similar results for other cases, which are evaluated on their individual merits.