Getting Fair Market Value: Business Valuations In Divorce Settlements
For a couple that owns a business, divorce becomes even more complicated. The disposition of assets can be a complicating factor in asset division during the divorce. If one spouse does not buy out the other, then the jointly owned business assets are divided through equitable distribution.
Reaching an agreement on the equitable distribution of business assets in a divorce can be complex. It requires a business valuation to determine what the assets of a business are worth. Often, the divorcing couple will disagree over the value of the company, requiring an appraiser to provide an expert opinion to help the court come to a conclusion.
Sometimes, there are competing valuations from two different appraisers. In this instance, the court could choose one appraiser’s value or make adjustments to either of the valuations so long as the court provides the rationale for those adjustments. When there are competing valuations, each appraiser would testify about how they determined the value and explain their credentials and why they are qualified to perform valuations on businesses.
All of this can feel overwhelming, and the future is not always clear regarding business valuations. If you are going through a divorce and share a business with your spouse, at Zachary D. Smith, LLC, we can help you through this process, whether you’re facing a competing valuation or just starting the process.
Business Valuation Methods And The Process
Even if divorcing spouses agree to sell business interests that they share, to do it correctly, they must determine the proper value of the business assets (including income) and the cost of liabilities.
After selecting an appraiser, they will request all needed financial documents to determine an overall financial picture of the business. These documents include tax returns, financial statements, business plans and general ledgers.
The appraiser then goes through an analysis of how the value of the business was determined. There are typically three approaches used when determining the value of a business:
- The income approach
- The asset approach
- The market approach
Each method focuses on a different aspect of the business; one may be better suited for a particular business than the others. The reason for valuation usually determines the choice of approach; the business’s size and the industry the business is part of are also considered.
Considering The Profit And Loss Statement: The Income Approach
The income approach is the most common method used to determine the value of a business and uses formulas and historical information to predict future cash flow and profits. The formulas used consider future benefits and the rate of risk or return.
The income approach has two general methods to value a business: single-period earnings capitalization and discounted future earnings or benefits. The method used depends on the circumstances of your business.
To value a business under the single-period income capitalization method, appraisers must specify three valuation elements:
- The expected earnings
- The appropriate discount rate
- The expected long-term growth rate in earnings
The fixed-period income capitalization method is typically the most straightforward compared with the discounted future earnings or benefits method, which allows for the modeling of growth revenues, expenses, and other sources and uses of cash over a projected period. This method looks at projected future cash flows, the discount rate and the terminal value.
Using Tangible And Intangible Assets In The Asset-Based Approach
The asset approach calculates a value using this formula: assets minus liabilities equals value. The formula includes tangible and intangible assets but sometimes leaves open the value of those hard assets.
Tangible assets include infrastructure, inventory and anything else related to the business that you can touch and physically exists. Intangible assets refer to non-physical objects including patents, accounts and goodwill. This approach takes into consideration everything from inventory to company cars.
Establishing Comparable Value: The Market Approach
The market approach appears relatively simple compared with the other approaches, but it comes with its own challenges. The market approach compares a business to similar businesses that have been sold, much like how appraisers will look at comparable properties in real estate.
This approach isn’t always reliable or possible, especially if the business is unique and there are no similar businesses that have recently sold. The market approach is more applicable when industry-specific data is available, such as with large companies and franchises. The market approach is the least favored approach in divorce matters.
Protecting Your Business Assets
When splitting your business assets, you should never cut corners. Whether you own the business jointly or have contributed to its success with your spouse, we can help you through the valuation process and ensure that you are working with the best experts for your case. Contact us now at 513-275-5367 or online to schedule a consultation.