This is the fourth part in a series discussing what happens when a married couple with shared business interests decide to divorce.
The first part of the series explains the types of business interests spouses may share.
The second part of the series discusses how a couple with shared business interests determine the future of those assets in divorce.
In our third part, we explored the issue of dissipation, an act by one or both parties involved in a divorce to misuse marital assets.
For the concluding part of our blog series on how divorce proceedings affect business interests, we’ll cover the importance of careful business valuation, the process of determining the economic worth of a business.
Valuation is relevant to any divorce in which business ownership is a factor. Even in cases where the business is legally owned solely by one party as non-marital property a family court judge will consider the business’ value in judgments in dividing the estate and the income from the business will be relevant to issues of spousal maintenance and child support.
How a business is valued in divorce proceedings
The process of calculating the total value of a business is far more complicated than it seems, when you consider all the elements a business may encompass.
First to consider is that most business portfolios include multiple items of value, including bank accounts, real estate, physical and intellectual property, equipment, inventory, liquid assets, investments, personal goodwill and more. The number of components contained within a business can affect the complexity of its valuation.
Additionally, businesses that have more complicated holdings provide an opportunity for people to hide money or abuse marital finances, heightening the need for financial valuation
A business valuation comprises several elements including a review of the financial records of the business, a management interview with the owner(s) as well as a review of relevant data available using valuation principles
Under Illinois law 750 ILCS 5/503(k), the value of a business will be set at its fair market value as of the date agreed by the parties or ordered by the court.
In general there are three common approaches to determining the value of a business:
· The market approach, which looks at recent sales of comparable businesses and then a price is set under the assumption that the business were to be sold now.
· The income approach, which looks at the business’s tax returns, profit-and-loss statements, accounting records, invoices, and customer contracts to place a number on the business’s earnings over the past few years. From that date, the valuators estimate future earnings. A variation of this method is the discounted income approach which reduces future earnings estimates based on specific business risks and circumstances.
· The asset approach, which adds up the current value of the business’s assets, including accounts receivable, minus any outstanding debts. The problem is that this “book value” is not always determinative of what the value truly is if on the market for sale.
Further, the valuator must consider what portion is attributable personal goodwill and because it is not transferable to any buyer of the business, Illinois courts have ruled that it should not be considered as part of the business valuation and therefore is not subject to division in a divorce.
A valuator will often employ all of these methods to determine the value and then select the value that in their professional opinion is best given the nature of the business. Remember the valuation process is an opinion of value and there may be much dispute become valuators as to the best determination of value.
Finally, value of a business can also be adjusted by discounts for items such as minority ownership or lack of marketability. These adjustments are a direct reduction from the value and are another important consideration.
What will a Judge do when determining value:
In divorce proceedings that involve business ownership, two distinct award judgments may result. One involves looking at the business as an asset of value and dividing that value at the time of the divorce decree. The other determines whether the future income of the business will be allocated toward child support or spousal support.
For the first type of judgment, a family court judge determines the balance of marital vs. non-marital property and awards a portion of the business value to each spouse. If one spouse keeps the business, the value may be offset against other assets or a buyout over time may be necessary.
In another, separate analysis, the judge considers the business owner’s projected income, and decrees what portion of it will be allocated to spousal support or child support payments.
These judgements stand separately, meaning that once the business’ marital value is divided in divorce, that same value cannot be also used in the calculation of support. The judge instead considers the business owner’s income in terms of salary and bonuses to determine what amount of spousal support or child support is appropriate for future payments. You cannot be awarded the value of the business and then all future income from that business operation. This analysis is highly complicated and must be analyzed on a case-by-case basis.
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If you own a business with your spouse and are contemplating or in the process of a divorce, it is important to discuss these matters with your Attorney. Call us to discuss your rights and options moving forward.
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