Understanding the valuation of a business in the context of a divorce is a complex topic that entails a number of detailed nuances. In a sophisticated property case, a business valuation can be the most contested issue before a court. Typically the court is not going to leave the parties in business together. One spouse will be awarded the business and the other will be awarded assets to offset the value of the business. Since the business value is a moving target compared to other tangible assets, there is a lot of room left open to argument and advocacy at the negotiating table and then, the courtroom. An attorney who has a command of business valuation and its presentation has a decided advantage in achieving his or her client’s goals in the resolution of the divorce.
A business in a divorce will be valued at a “fair market value.” Fair market value can be simplistically defined as the hypothetical price a willing buyer would pay to a willing seller with neither party under duress to buy or sell the business in question.
What Is Being Valued
Texas operates under the “entity theory,” which means the business owner does not have a direct ownership interest in the underlying assets of the business. What he or she owns and what is being valued is the actual partnership or corporate interest, not individual assets. It is the value of the business, as an operating company, that is being determined.
Business valuators typically employ three methodologies in assessing a business’ worth:
The first methodology employed is the asset method. This methodology inventories the assets of a business and then calculates the worth based on the value of those assets minus the liabilities. This approach has limited application and is often utilized to evaluate real estate holding companies, where the largest asset is the piece of property it is holding for future sale.
The second methodology employed is the sales/market approach. This methodology arrives at a value by reviewing the sales data of other similarly related businesses. The data collected is then used to determine a projected sales value for the company at issue. Finding meaningful sales data of comparable companies is usually difficult, at best, when evaluating closely held businesses.
The last methodology to be applied is the income approach. The income approach consists of reviewing a company’s current operations and making projections regarding future income and expenses. Within the income approach, there are two main underlying methodologies: the discounted cash flow and capitalization of earnings. Compounding the complexity of this approach is a number of additional valuation variables that must be applied. This is the most common approach used in arriving at the ultimate valuation number for companies. It’s also the most complex.
In general, all three methods are considered by the evaluator. The expert then determines which of the methods has the best application to the company at issue. This judgment call is one of many subjective choices an expert is going to have to make in arriving at his or her valuation conclusion. An expert’s ultimate conclusion may be based on all three methodologies or simply one or two of them, depending on their applicability.
Minority and Marketability Discounts
After the expert arrives at his or her valuation conclusion, that number can then be discounted based on a minority ownership or relevant market conditions. A minority discount assumes that a buyer will pay less to acquire a non-controlling interest in a company. A marketability discount involves the concept that an interest in a closely held business is not usually readily convertible to cash and will likely take time to sell.
Personal and Commercial Goodwill
The goodwill concept involves apportioning the value of the company between commercial and personal goodwill. Personal goodwill is the value that can be attributed to the owner’s reputation, skill, business contacts and relationships. An owner’s personal goodwill varies across the board. In certain cases, such as in professional practices, it may be a high percentage of the company’s ultimate value. The value of the portion attributable to personal goodwill is the owner’s separate property and is not subject to division as part of the community estate. The remaining portion of the value is commercial goodwill, which is not attributable to the owner. If the company in question is not one party’s separate property, then the commercial goodwill portion of the value is community property and is subject to division by the court.
The importance of the role of the business valuator in any complicated property valuation case cannot be understated. It is extremely important that you choose your business valuator with the same degree of care you had when you chose your attorney. Your attorney should have a good working relationship with this chosen expert and be familiar with the various intricacies of business valuation. In most cases, the business valuator will be required to reduce his or her opinions into a written report. This report states his or her conclusions and provides the underlying work product that supports those conclusions. The report will become the principal evidentiary basis presented to the court as the value of the company at issue. While an expert must be “book smart,” they must also be able to translate their knowledge and conclusions in a clear and understandable manner to a judge or jury.
Business valuation is part art and part science. A library could be filled with materials that have been written on this subject. Any attorney you entrust to this crucial role should have a deep understanding of how this process works and how it needs to be presented in court. The attorneys at Orsinger, Nelson, Downing & Anderson have that understanding. If you need help working out a fair property valuation in your divorce, contact us today.