Potential roadblocks to valuing a business in divorce proceedings
Divorce is never easy. But when the marital estate includes a private business interest, matters can become especially complicated. Here are some challenges that may be encountered when divorce proceedings require a business valuation.
Because divorce often is adversarial, the parties may withhold or slant information to protect their financial interests. For example, a spouse who owns a business might intentionally limit the opposing expert’s access to documents, facilities or management personnel. Or the owner-spouse might alter accounting records or hide assets.
A valuation expert who’s involved in the discovery phase can compile a list of key documents and procedures to request from the judge. It’s important to obtain court approval of document requests, site visits and management interviews even in amicable cases, because in divorce it’s not uncommon for relations to sour overnight.
Additionally, if things don’t add up when reviewing documents and oral commentary, the expert will either conduct a forensic analysis or, if the irregularities are outside his or her expertise, refer the nonowner spouse to a forensic specialist.
States vary significantly on the treatment of goodwill. Some include all goodwill in the marital estate. A few jurisdictions exclude all goodwill. In most states, however, goodwill is split into two parts:
- Personal/professional goodwill, and
- Business/entity goodwill.
In states that differentiate between these two types of goodwill, personal/professional is attributable to the owner’s efforts and, therefore, is specifically excluded from the marital estate. Bifurcating goodwill is subjective and often contested.
When choosing the effective date to value a business in a divorce assignment, there are several options, including the:
- Separation date,
- Divorce filing date, or
- Trial date (or as close as reasonably possible).
Generally, the attorney tells the valuation expert which effective date is appropriate. But sometimes this issue is resolved by court mandates or mutual consent of the parties. If this issue is left undecided, the expert may need to calculate separate values for each date. To complicate matters, cases that involve premarital assets may require multiple valuations to determine how much the business appreciated during the marriage (the current value of the business less the value of the business on the marriage date).
Discounts and premiums
Two common adjustments are discounts for lack of control and marketability. Hypothetical investors place a premium on 1) the ability to control management decisions and 2) the ability to quickly convert the investment into cash. Conversely, business interests that lack either (or both) of these abilities may need to be discounted.
Applying and quantifying these discounts is well documented in U.S. Tax Court cases, but family court cases are less clear. These adjustments can be significant — say, 20% or 30% of the company’s value (or more). Experts support their stance on valuation discounts with relevant statutes, legal precedent, and the case’s facts and circumstances.
In addition, some discounts and premiums may not be stated explicitly in a valuation report, but rather be implicit in the valuation methodology. Other, less common discounts, such as adjustments for reliance on key people and built-in capital gains tax, also may be relevant.
Expertise is critical
When marital assets include a private business, it’s usually the largest asset in the estate. So you can’t afford to leave matters to gut instinct or the whim of the court. Contact us to discuss valuation matters, including goodwill and how much should be included (or excluded) from a couple’s marital estate, based on relevant legal precedent and case facts.