Understanding the Valuation of a Closely-Held Business


Tomekia Lee-Chaney, Contributing Author

In divorce suits, it is common practice to provide the value of personal and real property to aid in the division of the marital estate. Of the properties owned by spouses, ownership in a closely-held business may significantly affect the outcome of your divorce.

The process of obtaining and interpreting a business valuation can be intimidating for both attorneys and their respective clients. However, having a basic knowledge of the importance of selecting the right valuation expert for your business and understanding how business valuation works will hopefully put you in a much better position.

Ownership interest in a business is an important investment that warrants the same attention as any other asset or investment property owned. In many states, the owner of a business is able to testify before the court regarding the value.

However, depending on the type of business, length of time in operation, the owner’s role, share of interest and knowledge of the day-to-day operations, the owner’s professed value of his business may not be recommended or widely accepted. Early in the suit, it is imperative to determine whether it is appropriate for the business owner to report the value, or if hiring a third-party valuation expert will be necessary.

Business valuation professionals specialize in providing expert witness testimony for a variety of legal situations, including divorce. There are varying licensures, accreditations and memberships in financial organizations that further dictate standards for a valuation expert, who must follow mandated guidelines to ensure the final calculation conforms to state and federal laws.

Photo By: reynermedia
A business valuation professional assigns an accurate value to your stake in a closely-held business and can testify as an expert witness in court.

Once a valuation expert completes their calculation, he or she will provide a detailed or short-hand rendition of the report reflecting the value of the owner’s interest and the manner in which that value is derived. The length and specific information in the report will depend on the expert retained and the type of report requested. It is important to be specific in your request; otherwise, you may end up with a report only the expert is able to interpret.

Once the valuation expert and style of the report is chosen, the attorney will enter into an engagement letter with the valuation expert specifying the following: the persons involved in the marriage dissolution lawsuit, the reason the valuation is sought, the name of the business, the owner’s percentage of interest in the business and the valuation date of the business.

After paying the retainer fee to initiate services, the valuation expert will be in direct communication with the attorney and/or owner of the business in order to obtain specified documents needed to begin the valuation process. The specific items needed may range in scope from the Certificate of Authority from the Secretary of State to Federal Income Tax Returns.

The business valuation process

There are four important factors used by the valuation expert to create the value of the owner’s interest in the business: The standards of value assigned to the business, the premise of value, the valuation approach of the business and the discounts attributed to the lack of control and marketability.

Standards of value

There are three commonly used standards to determine a value of a business:

  1. Fair market value, which is generally used in determining the value of a closely held business. It reflects the price a hypothetical buyer would pay to a hypothetical seller for the asset with both the buyer and seller possessing preexisting knowledge of relevant data.
  2. Fair value, which is often used when a market does not exist to compare the asset against.
  3. Investment value, which is often used when an interested buyer specifies a value of the asset.

The valuation expert must identify the standard of value to apply before proceeding with the premises of value.

The premise of value

Premises of value are used to describe the manner in which a hypothetical buyer and a hypothetical seller handle the sale of the business. It determines whether the valuation will consider if the business were to be sold during its continued operation or during liquidation.

The valuation approach

There are three approaches that must be taken into consideration when valuing the business:

  1. The asset based approach, which is used to obtain the value of the business assets minus any liabilities;
  2. The income based approach, which is used to obtain a value based on a speculative amount of future income to be received; and
  3. The market based approach, which is used when obtaining a value based on a comparison between the owner’s business and other businesses closely related to the owner’s business.

Once again, the valuation expert will be able to identify which approach is most applicable.

The discounts attributed to the lack of control and marketability

Upon determining the standards of value, the premise of value, the value approach and ultimately securing an appraised value of the business, the valuation expert must determine whether any discounts exist to reduce the appraised value to a lower amount.

When a valuation expert reduces the appraised value of a business, they are taking into account the actual amount of control and marketability held by the owner, in comparison to the interest and liquidity of the owner’s interest in the business. For instance, if a business owner has a 20 percent interest in his business, the ability to dissolve his interest is diminished by his lack of a majority interest.

Getting your fair share

In a divorce, the value of a business should be obtained before your final court appearance to dissolve the marriage. Becoming aware of the basic factors sought in valuing a business may assist you in preventing your spouse from receiving a share of the business in excess of its true value.

If you own a stake in a closely held business, be sure to discuss with your attorney what steps need to be taken to hire a business valuation expert that is right for your situation to ensure an accurate valuation is acquired. If your share in a business is overvalued, you can end up losing out on your fair portion in the marital estate.

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