The Business of Business Valuations and Divorce
Divorce is already a hard enough process without worrying about your business. Unfortunately, that's often unavoidable.
Business owners often face many competing demands of their time and energy: employees, clients, human resources and strategic growth, just to name a few. When that business owner is facing the possibility of a divorce, the stress can mount: How will divorce impact my business interest? Am I going to be forced to co-own my business with my former spouse? How will it even be possible to value my business interest?
READ: How Much is Your Business Worth in a Divorce?
How will divorce impact my business interest?
While these concerns are not uncommon, there is a method to how many of these questions get answered. In Colorado, the value of a business interest as determined during a divorce is based upon the value at the time of entry of the divorce decree. If the parties cannot come to a mutual agreement about the value of a business or the business interest is too hard for them to value, they can hire a business valuation expert to help them determine the value. Valuation experts work with both parties jointly to determine the value of the interest. In completing financial disclosures, the owner of the business interest(s) would disclose relevant financial documentation to the other party, and both parties have a duty to cooperate with the expert to assist in completion of the expert report.
How will it even be possible to value my business interest?
When determining a business’s value, the expert will primarily look at three different valuation methods: the asset approach, the market approach, and the income approach. Each of these categories has sub-categories that are tailored to your specific type of business interest.
For example, an asset approach would likely consider the multiple assets the business owns and what the liquidated value of the business’s assets would be, while the market approach often considers other similar companies and market data similar to your business interest to determine value. The income approach considers the capitalization of historical earnings.
Some sub-categories used underneath these three primary categories may be a hybrid approach for the two. For example, the excess earnings method is a hybrid approach of both assets and income, considering what “excess earnings” a person might make as a business owner doing similar work to a W2 employee, and how that excess contributes to value to the person.
A business valuation expert is likely to apply a discount rate which is used to convert future dollars into a present value for the present valuation of the business interest. Businesses with a higher cash flow or faster growth rate are likely to be more valuable as they may have more certain future cash flows, while businesses with less certain cash flows are riskier, which reduces the value of the business.
Am I going to be forced to co-own my business with my former spouse?
At the end of the process, the expert produces the report for the parties’ review, including the underlying data that was considered. You might disagree with the analysis and may feel it important to hire a rebuttal expert to review and give feedback on the method used to value the business or errors that affected the valuation. If the parties cannot use the expert report to come to agreements on the value of the business, the parties will go to a contested “Permanent Orders” hearing where the court will consider the testimony of these experts and make determinations, in line with the law in the state, as to the value of the business.
Just because a business is owned exclusively by one party does not negate that there can be a marital property interest in the business. If the business was owned by one party at the time of the marriage and remains owned by that party, a historical value of the business may be necessary to determine the increase in value of the business during the marriage: the increase in value is marital property subject to division.
If the business began operating during the marriage, its entire value is likely considered marital property. For example, the parties in a case might own a $500,000.00 home with no mortgage and one party’s share of the business interest might be $500,000.00, for a combined marital estate of $1,000,000.00. The court might decide that one party keeps the marital residence, while the other party who owns the business interest keeps their business interest.
Remember, Colorado requires an equitable division of property, not an equal division. Likewise, it is likely that any business interest that is allocated to you that produces income may “double dip” by being considered both an asset allocated to you and a source of income for spousal maintenance, if ordered.
The Bottom Line
Business owners who are expecting a divorce should speak with a family law attorney and consult with a business valuation expert to determine the best course of action. Divorce is already a hard process, and you deserve to protect your hard work and your future.
Anthony Zarsky is a Senior Associate at Griffiths Law in Lone Tree, CO. Anthony’s practice focuses on complex financial divorces, parental responsibilities including substance abuse issues, protection orders, cohabitation agreements, and zealous advocacy for his clients.