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Divorce Resources for Women

How to Understand a Business Valuation in Your Divorce

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Your wife is a very successful dermatologist. She owns a practice with 3 other doctors. Your family lived the life of their dreams until your wife cheated with your neighbor and told you she was leaving you.

You don’t earn nearly the income she does. Her career came first and yours always took a backseat.  You are counting on receiving money from her business to assist you financially until you can re-energize your own career. You supported her and were always there to pick up the slack with the children when she was at work.

But now your wife says the business isn’t worth much. They have struggled the last few years because of a new competing practice in town.

You suspect this is not true. You don’t have access to any of the financial records of the business. But you know that her paychecks didn’t decrease. They only increased each year.

What are your options when you believe a marital business is worth more than an Ex will admit?

How do you find the value of a business? What would a court consider?

What is a business valuation?

When ex spouses cannot agree, and they often don’t, about the value of a business, oftentimes a business valuation must be done by an appraiser to place a value on the business for purposes of the divorce and dividing assets and debts.

The purpose of placing a value on a business is to determine the marital interest of each spouse. Of course the spouse involved in the business will often want the business to be a lower value and the spouse entitled to an interest in the business will want the value to be higher.

Business evaluations are not done in every divorce case. This could be due to several factors. It may be because the business isn’t worth that much or the parties agree to divide the assets of the marriage without having a professional value the business.

Business valuations are typically done for businesses that are worth a substantial amount. It is rare you would pay to value a business such as a small lawn care business or an in home daycare run by your ex spouse.

Examples of the types of businesses that often need business valuations are medical practices, technology start-ups, dental practices, dermatology practices, accounting firms, constructions companies, large farming operations, and the list goes on and on.

What does the business valuation look like?

The business valuation is a typed document and is usually several pages. It contains a table of contents that outlines how the valuation is organized. This is a great reference page to obtain an overall picture of what the valuation contains.

The first page usually contains a summary that will give you the value that the appraiser determined the business is worth.

Most business valuation appraisers will use multiple methodologies to value a business and each methodology will be listed in the appraisal including the reasons each method was chosen.

The remaining sections of the document go step by step outlining how the appraisal was done and the methods the appraiser used in valuing the business.

What is the first step in the process?

Selecting an appraiser is the first step in the process. It is important to do your research and select a very experienced appraiser.

Who is an appraiser? Appraisers are individuals that have the necessary educational, training and experience to value businesses. Their job is very similar to that of a Real Estate appraiser.

Real Estate appraisers go into a home and look at all the characteristics of the home. They look at what other similar homes have sold for in the area. Then they place a value on the home.

Much like a real estate appraiser a business appraiser does the same for a business. The appraiser looks at all the financials and the inner-workings of the business to determine a value for the business.

Depending on the type of business, it may be important that the appraiser has valued that particular type of business in the past.

Review the credentials of the appraiser as well as the number of overall appraisals he or she has prepared.

It is also important to determine how many times the appraiser has actually testified in a divorce case about their preparation of a business valuation. If your case does go to court, you want the appraiser to be experienced and familiar with the process of testifying in open court.

Judges often rely heavily on business valuations in divorce cases because it is the most reliable source of information that a Judge would have other than testimony from each party and possibly employees of the business.

What does the appraiser need to begin the valuation?

The most important next step after the selection of an appraiser is the document gathering process. Most, if not all, of the documents the appraiser needs to review will be in the possession of your Ex.

Prior to engaging an appraiser, you would either have requested all of the financial documents needed through discovery (which is the formal process used to request documents from an opposing party (the Ex)) or the opposing party has voluntarily provided the documents and agreed to the valuation.

The appraiser utilizes the documents to obtain an overall financial picture of the business.

Examples of the types of documents used by the appraiser:

  1. Tax Returns
  2. Financial Statements
  3. General Ledgers
  4. Checking/Savings Account Statements and accounts of the like
  5. Balance Sheets
  6. Business Plans
  7. Marketing Materials Used By the Business

The list will vary depending on the type of business.

What other sources of information does the appraiser use?

There are certain recognized books and periodicals that appraisers rely on to assist in determining a value.

The U.S. Bureau of Labor Statistics and/or the Census Bureau often provide information that an appraiser would rely on.

There could be any other number of sources that an appraiser could use that are recognized as legitimate in determining the value of certain businesses.

In the business valuation report, the appraiser will list each and every source they relied on as a source of information in the valuation process.

The appraiser has the documents/information, now what?

The appraiser then goes through the analysis of how the value of the business was determined.

The first step is describing the approach the appraiser would use.

There are three approaches that are typically used in determining the value of a business interest: the asset approach, the market approach, and the income approach.

The asset approach calculates a value using a fairly simple formula: assets minus liabilities = value. Assets include both tangible and intangible assets.

Tangible assets include the infrastructure, inventory, and anything else related to the business that you can actually touch.

Intangible assets are patents, accounts receivables, and other assets that are not actually physical objects. While this approach seems straightforward, it can actually be rather difficult.

For instance, how do you place a value on the business assets? Some items, like company vehicles, may be easy to value by using a value book. Other items, such as the computers in the office, or the tables in a restaurant would be harder to place a value on.

Additionally, an issue arises when it comes to valuing inventory as well. Typically inventory is valued at cost, but this can vary based on the age and type of inventory. Further, there may not be a value book that covers the type of inventory at issue.

This approach also doesn’t take into consideration any unrecorded assets and liabilities which could create further issues; consider a significant unrecorded loan being given to a family member around the same time the business was being valued.

The market approach calculates the value of a business by comparing it to similar businesses that have been sold. This approach is similar to how appraisers will look at “comps” in a neighborhood when determining the value of the house being appraised.

This approach can prove difficult, however, if there are no similar businesses that have recently been sold that can provide an accurate comp.

The income approach uses historical information and particular formulas to predict expected cash flow and profits in calculating the value of the business. The formulas used consider future benefits as well as the rate of risk or return. This is the most common approach used to determine a value of a business.

The reality is each of these approaches is probably utilized to some degree in each business valuation as the appraiser attempts to determine an overall value.

How does the business valuation help me in my divorce case?

The business valuation document provides a tangible document with an actual number value on the business that can be used in the ultimate division of the assets and debts of a marriage.

The document can be used at mediation or in court. If the document is used in court the appraiser must be present to testify to its contents. In mediation, the document itself is usually sufficient. It would be one of many documents reviewed in mediation.

The process is less formal in mediation so the more strict rules of evidence would not be followed so the appraiser would not have to be present.

It could be that the parties agreed on one appraiser and only one appraiser was used, or each party may pay a separate appraiser to each have their own independent valuation.

In court, if there are two competing valuations from two different appraisers with different values, the court could decide to choose one appraiser’s value over the other or take an average of the two values.

If the matter does go to court, each appraiser would testify in open court about how the value was reached. They would further explain their credentials to the court that makes them qualified to perform valuations on businesses.

The Judge, as usual, is the ultimate fact finder and decision maker. They would then decide the value that should be placed on the business so that the assets and the debts of the marriage could be equitably divided.

Divorcing and dividing assets and debts is never a fun process. In fact, it can be extremely stressful at times. The more concrete knowledge you have of the assets and debts of the marriage, the better equipped you are to know what a fair settlement would be. Knowing a true value of a business is very helpful in the process.


 

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