How much is your business worth in a divorce?

Many business owners are shocked to learn how their businesses are valued during a divorce or a partnership dispute.

Any partnership dispute or divorce case that involves a company often requires a business valuation to determine the value of the owner’s interest. 

Many business owners find that their businesses are worth much more than they realized, especially smaller businesses that are less marketable and more valuable to the owner.

Many professional services companies, such as lawyers and doctors, will find that their practices are worth far more than they could ever sell them for on the market.

This is because many service-based businesses derive their value primarily from the professional goodwill and future earning potential of the business rather than the value of the tangible assets.

It is crucial for business owners to understand precisely how a valuation expert will value their companies, and planning ahead could substantially impact the case’s outcome.  

How Do You Calculate How Much a Company is Worth?  

Valuing businesses is both an art and a science. The process involves evaluating all aspects of the company, including the tangible assets, historical earnings and performance, growth stage, future earnings, and any comparable market transaction data. The valuation methodologies can vary significantly depending on the type of business. 

For example, it is typically inappropriate to value a professional services business using an asset approach because professional service companies usually have minimal assets and derive their value primarily from income. 

Valuation experts commonly employ one of three valuation techniques: (i) the market transaction approach, (ii) the income approach, and (iii) the asset approach. 

While numerous labels and phrases are used in the industry, virtually all business valuations fall into one of these three major categories. Most credible valuation experts typically attempt to value businesses using multiple approaches (if possible) and use the various approaches to cross-check the conclusion. 

In many circumstances, the valuation expert may blend the conclusions by weighting two approaches based on whichever approaches he or she feels are the most appropriate and reliable. 

Market Transaction Approach: 

The market transaction approach generally relies on industry data to evaluate how a particular company compares with other companies that were bought or sold in the same market segment. 

This approach is widespread and reliable for particular market segments where current and reliable industry data exists.  Good examples would include franchises that are commonly bought and sold around the country and where the transaction details are publicly available. 

If reliable data exists, valuation experts will compare metrics such as revenue or EBITDA to compare the company in question to other market transactions. 

The major downside to the market transaction approach is that most small businesses do not have readily available market comparisons, and even when they do, the comparisons may not be that reasonable. Therefore, business owners should always pay careful attention to evaluate whether the market comparisons are accurate and justified.   

Income Approach: 

The income approach is the most common method and typically can be used to value most businesses.  The income approach values a business based on the company’s ability to generate profits in the future.  

Explained simply, the valuation expert will use historical financial data to project future earnings of the company.  Those projected future earnings are then discounted back to net present value (NPV) to determine the company’s current value. 

Variations of the income approach are most commonly used to value professional services companies such as law firms, financial advisors, and medical and dental practices.

However, the income approach is often very controversial because the valuations are typically far greater than what a business owner could ever sell the business for on the market. 

It also requires the business owner to write a large check to their spouse or transfer equivalent assets in exchange for the right to continue working and enjoying the income streams in the future. 

Asset-Based Approach:  

The asset-based approach measures the fair market value of a company’s assets, less any liabilities.  This approach is appropriate for companies that derive their value from acquiring, holding, and selling assets. 

Real estate holding companies are the most common example of a business that would likely be valued using an asset-based approach. 

If the real estate assets also produce income, the valuation expert may apply a hybrid approach that blends or weights the asset approach and income approach together. 

Another example might be a car dealership or an entity that owns a valuable art collection. The asset-based approach often relies heavily on appraisals to value the underlying assets owned by the company and is typically less effective or reliable when valuing intangible assets such as professional goodwill.   

Business owners facing the prospect of divorce or a partnership breakup should carefully consider their options and educate themselves on the process.  If it is a partnership dispute, there is a strong possibility that the operating agreement or shareholder agreement will dictate how the court or business valuator will determine the value.  However, it is doubtful that the operating agreement or shareholder agreement will dictate the value in a divorce case because Colorado law protects spouses from business owners trying to game the system.  No matter what kind of dispute a business owner is facing, it is always prudent to educate yourself on the process and seek quality legal advice well in advance of a dispute.     

Duncan Griffiths is a Shareholder at Griffiths Law PC. He focuses his practice on difficult and complex civil litigation and family law matters. He has significant experience in a variety of fields including construction defect, insurance, real estate and commercial litigation. 

Kim Newton is an Associate Attorney at Griffiths Law PC. She focuses her practice on both civil litigation and family law. She works closely with Duncan Griffiths in several fields, such as real estate disputes, insurance bad faith, construction defects, commercial litigation, and other business torts. 

(Content for this sponsored article provided by Griffiths Law PC)