The following article was written by an associate at our affiliate, Wipfli LLP. With more than 2,000 associates in offices across the United States and in India, Wipfli ranks among the top accounting and business consulting firms in the nation.
Divorce is a decision that can be influenced by many emotions. But regardless of where a couple falls on the emotional spectrum — whether the decision to divorce is mutual or divisive — the process of separating assets and liabilities is complex. And when one of those shared assets is a closely held business, it can become even more complicated.
During divorce proceedings, the court will categorize a couple’s assets as marital or nonmarital and determine their value before disbursing them to the appropriate party. It’s critical to assign the most accurate value to each marital asset. Tangible assets like a car or house have market value so assigning value to them is typically less complicated. On the other hand, it’s far more challenging to assign value to a business and, as a result, the process requires specialized knowledge and guidance.
Here are the key factors and approaches business owners should consider before commencing the valuation process during a divorce:
Know the Difference Between Marital and Nonmarital Assets
Marital assets are those that you acquired during your marriage with shared funds. Conversely, assets that you acquired before your marriage with separate funds are classified as nonmarital assets. Your business will be classified as either a marital or nonmarital asset based on when and how you acquired or founded it. If your business is considered a nonmarital asset, but it expanded or increased in value while you were married, the court could classify it as a marital asset and therefore divide between you and your spouse.
When it comes to classifying assets, you should also understand the concept of goodwill. There are three types of goodwill:
– Entity: This type of goodwill encompasses elements such as the business’s name (in other words, its inherent value in the marketplace), its location and any patents or trademarks it holds.
– Personal: This includes both your personal and customer relationships, and your specialized knowledge about the company or industry. Essentially, personal goodwill encompasses any element of your business that may be transferred to another person.
– Nontransferable: Nontransferable personal goodwill pertains to skills — for instance, skills a surgeon uses to practice — which you can’t pass on to another person.
During divorce proceedings, it’s critical for you to differentiate between entity and personal goodwill and categorize marital assets accurately and appropriately. These are tangible issues that could affect your business’s valuation and the process is exceedingly complex; in many cases, both spouses’ attorneys make arguments in favor of or against an element of goodwill. If you want to learn more about the process of determining personal goodwill in a commercial company, check out my article on the topic.
Consider Three Approaches to the Valuation Process
If one of the assets you’re classifying in your divorce is a business, any portion that falls into the “marital” category must be valued. To avoid any hang-ups in the process such as a Daubert challenge, it’s important to hire an experienced professional with ample knowledge and credentials. Hiring a specialist in business valuation will be essential to helping you determine the included fair market value of your company. You should narrow your search to certified public accountants (CPAs) accredited in business valuation (ABV), certified business appraisers (CBAs) or accredited senior appraisers (ASAs). From a financial perspective, it’s also beneficial to enlist the help of a Certified Divorce Financial Analyst® practitioner. These professionals can be important resources in helping assess what needs to be valued and the interest held. Your team will also communicate directly with your lawyers and the court to identify the “as of” date of the valuation.
When valuing a business interest, professionals typically use one of the following methods:
1. The Asset-Based Method
Using the asset-based method, professionals compute the value of a business by identifying the fair market value of tangible and intangible assets less liabilities. Think of tangible assets as anything related to your business that you can physically touch, such as infrastructure or inventory. Intangible assets are those that aren’t physical objects, such as patents or trade secrets.
Note that you typically shouldn’t use the asset-based valuation method if you have a minority interest or a profitable operating business. Rather, this approach is more commonly used for companies that don’t have profitable income or in cases where fixed assets are a core component of the business.
2. The Income-Based Method
The income-based method is focused on the present worth of long-term economic benefits. Using this approach, an appraiser will assign selected discounted capitalization rates to anticipated cash flow and profits, and then calculate the value of the business from there. This approach factors in future benefits and the rate of risk or return.
Typically, at Wipfli — which is an affiliate of Wipfli Financial Advisors — we evaluate business cycles and five-year histories to help project forward. However, if the past five years are not reflective of the company’s future, then we use other projection approaches.
3. The Market-Based Method
With the market-based method, an appraiser analyzes the value of a company by comparing it to similar public companies or similar companies that have sold. This is akin to the process of looking at comparable homes in your neighborhood to help determine the value of your house.
Seek Insight From the Outside
Different perspectives and attitudes often arise during divorce. When it comes to the valuation process, getting a second, third-party opinion can be essential to helping you reach the most favorable outcome for both parties.
If you and your spouse have different viewpoints on the fair market value of your business, you may need to engage in a fair market value deposition. By hiring a specialist in business valuation to help facilitate the process, you’ll have comprehensive support in preparing the valuation and a resource who can determine an accurate fair market value. Plus, your business valuation specialist can also provide expert testimony in court.
The stakes are high when two business owners navigate a divorce. Whether you need help categorizing your assets or determining value, a Wipfli valuation specialist can help. Contact our team today.