When dividing marital assets, courts have broad discretion to assign a value to the asset and determine how to divide that value among the parties. Because of this discretion, it is very important to assign an accurate value to each marital asset.
The value of most assets is fairly easy to determine; cars, retirement accounts and homes all have a market value. However some assets, like a business for example, are not so easily valued.
Most businesses are not large enough to have a well-defined market value, and figuring out how to divide the asset during a divorce can become very contentious.
In high-networth divorces, it is not uncommon to see both parties hire experts who will value businesses and testify to the court how they came to that valuation. In smaller-asset divorces, the parties will generally attempt to value the business themselves.
If you are going to attempt to value a business yourself, it is important to understand the valuation process.
Assets and liabilities
The first step in determining the value of a business is to understand its assets, which generally include all tangible and intangible property.
Tangible property is inventory, savings accounts and equipment necessary for the business to operate. Intangible property is goodwill with clients, patents and trademarks or software. The main idea is that anything which makes the company money is an asset.
Liabilities are considered all things that cost the business money. These include loans, payroll and any other money, goods or services that the business may owe.
Generally, you take the total of all assets and subtract the total of all liabilities to form a starting value for the business.
The income of the business
The profit of a business is generally how much money the business makes (income) minus how much it costs to operate the business (expenses). The remaining balance is the business’s net profit.
Income is typically defined as the total amount of cash received for all goods or services provided by the company, including any investment related income or income from the sale of business assets.
Expenses are considered to be the cost required to make the income. This includes employee salaries, advertising, equipment, etc.
The net profit of the business is calculated for certain time periods – weekly, monthly, quarterly or yearly.
Methodology for valuation
The two most common business valuation methods are the book value method and the market approach of valuation.
The book value of the business is what the business claims its assets are worth in the corporate books. The book value is generally calculated as the original cost of the asset minus depreciation of the asset based on its age and adjusted for any increase in value due to market fluctuations.
Assets such as automobiles and equipment generally depreciate in value over time while assets such as real property will often increase in value over time.
The market approach of valuation is based on the value or earning capacity of the business. This method looks at what an outside buyer would pay for the business.
Generally, the rule of thumb is to look at the business’s income and its value of assets over the past 5 years, looking for trends in income (either an increase or decrease) and attempt to guess what the business will do over the next 5 years (accounting for any changes such as an increase in marketing or increased operating expenses).
The date the valuation was completed
While the date of the valuation may seem like an insignificant point, it can become one of the most important. Divorces can take several years, and a valuation of business done at the beginning of the divorce may not be accurate on the date of trial.
It is important to try and have the business valuation completed as close to your hearing as possible.
Determining the value of a business can be very difficult and confusing, even for the business owner. Even more difficult can be explaining the value to a judge who ultimately will decide how the business is split among the parties.
That is why it is so important to have an attorney who not only understands what is necessary to value a business, but can also competently explain your methodology to the court.