Divorce is hard enough even when the circumstances surrounding the couple are simple. The spouses may have few assets, no children, and no disputes about alimony, yet still go through an emotionally draining experience.
The situation becomes much more difficult when one of the spouses owns a business. The business becomes part of the marital property, and thus subject to division and issues related to ownership. A divorce can become especially factious if one of the parties has devoted years of his or her life to building the venture. The settlement negotiations can become even messier if the company generates a considerable amount of cash.
In this article, we’ll discuss how divorce can affect a family-owned business. Along the way, we’ll describe the ownership issues that surface. We’ll also explain the different valuation methods used to determine how much of the company each spouse gets in the settlement.
How A Family-Owned Business Is Treated During A Divorce
Like any asset, a business is considered either separate property or marital property. Much depends on when it was launched, the date of the couple’s marriage, and which spouse contributed funds to the company since its launch.
For example, suppose a business was launched after marriage and both spouses contributed funds to its operation and growth. The company would likely be considered community property. Even if the business was launched prior to marriage, it can still be considered community property if both spouses contributed funds to it.
If a business was started prior to marriage and only one spouse contributed funds to its operation, it would likely be considered separate property. As such, it would not be subject to division. Nor are there any ownership issues to contend with.
Having said that, most closely-held, family-owned businesses receive some type of contribution – financial or otherwise – from both spouses at some point. As a result, the companies are usually considered marital property to which both parties in a divorce have a claim.
Dealing With Ownership Issues Following A Divorce
Once a judge has established how much of the company is owned by each spouse, the company’s fate can be decided in 3 ways. First, it can be sold with the sale amount split between the parties according to their respective ownership percentages (after the company’s bills and outstanding loans are paid).
The second option is for the couple to continue operating the business, but to do so as partners. Both would own a portion of the company and would have a claim on a corresponding percentage of its profits.
The third option is for one party to buy out the other’s interest. The buyout can be done with cash, other assets, or through a payment arrangement. Such an arrangement might require the buyer to make monthly payments for a specified number of years.
In order to effect a buyout, the value of the business must be determined. There are a few methods for doing so., which we’ll briefly cover below.
How To Value A Closely-Held Business
First, it’s unlikely that either spouse will be able to accurately value a family-owned business. The job requires a deep familiarity with the most common valuation methods, and an ability to determine which method is most appropriate for the company in question. That is usually the domain of a professional appraiser.
One method that is often used is called the income approach. Here cash flow has a major influence on how much the company is worth. Its future profits are forecasted – based on past sales and growth rate – and then discounted into present-day dollars to arrive at a value.
Another method is to calculate the value of the company’s assets and then subtract its liabilities. The idea is that a potential buyer would be disinclined to pay more for the business than the net worth of its assets.
A third valuation method involves reviewing recent sales of similar companies. The rationale is that the dollar amounts of the sales indicate a similar value for the divorcing couple’s business. The challenge is finding recently-sold companies that are comparable.
Valuing a family-owned business is not an exact science. It’s not a simple matter of multiplying the number of outstanding shares of stock by the price of a single share. The process is much more complex and oftentimes rife with ambiguity. It’s not uncommon for both spouses to hire appraisers who come up with entirely different valuations, setting the stage for litigation.