By Smolin Lupin, AAML NJ Gold Sponsor
Given the daily work they do to maintain their business, many business owners think they know everything a person can about the business, inside and out. However, that everyday experience doesn’t necessarily mean that the business owner can value their business accurately.
Particularly in a divorce, where emotions run high, a business owner, spouse, or a spouse who is a co-owner may not have as clear a picture of the business’s financial value as they would like to think.
Therefore, having a valuation done by a valuation professional can be immensely helpful in putting together an accurate financial picture of the business’s worth—and setting the stage for a potentially amicable divorce.
In the discovery phase, all relevant documents related to the business’s finances are gathered for review. This process can be pretty straightforward or a source of tension, especially over which documents are considered relevant. Having one of the parties attempt to block access to records through claims of “overreaching” can considerably extend the back-and-forth.
If the business owner owns more than one entity, it may also be necessary to combine the operations of various entities to come up with the cash flow relating to the owner’s interest in the combined business enterprise.
Family law attorneys can work with their clients to gather and make copies of the relevant documents early in the process to reduce the likelihood of the opposing party blocking the valuation professional's request for documents. Unfortunately, the longer the wait to gather the documents, the more objections are raised, and the more likely it is that the process will become a significant challenge with increased cost caused by the motion practice and third-party subpoenas.
Complications can arise if more than one person has an interest in the business or its related entities. For instance, if a family member owns a real estate entity leasing the building to the company in question, adjustments may need to be considered to adjust the rent to fair market value based on a real estate appraisal.
Due to the family connection, the rent may be lower or higher than the market rate. Moreover, there may be instances in which there are intercompany loans between the various entities. As part of the forensic analysis, it will need to be verified that the loans are indeed loans (and not disguised distributions) and that the intercompany balances agree between the various entities. The multi-entity business structures lead to more complicated valuations.
There are also instances where a business needs to be valued over multiple dates.
Suppose the business interest is in part premarital. In that case, the business will need to be valued at the date of marriage and the date of divorce complaint to determine the incremental increase in value subject to equitable distribution.
Additional steps and valuation periods may need to be considered if interests were acquired through gift or inheritance during the parties' marriage. While an initial valuation may have been done for gift tax purposes, the valuation would need to be reviewed to determine whether it accurately captures the value at the point of the gifting transaction. The valuation may also need to be adjusted from a fair market valuation to a fair value valuation to adhere to the law in New Jersey. Suppose the parties are unable to stipulate to the prior gift tax valuations. In that case, business valuations may also need to be completed as of the acquisition date and then compared to the values at the date of the divorce complaint.
Approaches to Business Valuation
When it comes to valuations, it’s essential to understand and explain to your client the three different approaches to valuing a business: income, asset, or market.
To value a business by its income, a valuation professional looks at historical income and current income, as well as risk and other business-related benefits. They then calculate the business owner’s income in the future based on the expected rate of return (as drawn from historical patterns) or by using other forecasting information.
The asset approach considers and values tangible assets (i.e., anything physical, like inventory or a building) and intangible assets (i.e., assets such as patents and goodwill). Liabilities are then subtracted from the total assets to determine the net value.
However, the process can get complicated if the tangible assets aren’t easy to value, as is the case with restaurant furniture, fixtures, or other used items.
A market approach aims to determine how much the business owner would get if they sold their business. In this approach, the valuation professional makes comparisons to other similar companies that have been sold.
Suppose the business owner has an active intent in selling a business, which may be revealed through the discovery process. In that case, a market approach may be more relevant to the value of the business interests.
A Clear Picture
Even in divorces that seem amicable, one spouse can hide the actual value of the business from the other. This situation comes to the surface more often if one spouse is involved in the company and the other isn’t.
Conversely, it’s common for the non-business owner spouse to think of the business as providing a steady stream of income while the profit margin can sometimes be very thin.
In both instances, your clients benefit from obtaining a professional valuation of the business rather than allowing an over- or under-valuation to result in one person taking a financial hit that may not be fully evident until years later.If you’re handling a divorce case that requires a business valuation or have questions about the process, the experienced professionals at Smolin Lupin can assist you—get in touch.