During a divorce, it is difficult to equitably divide a business–whether it’s owned jointly or by one spouse. Concealed assets and understated revenue are common accusations; a proper and fair valuation of the business is the best way to ensure the division is fair.
The standard of value is the method chosen to measure a business’s true value during divorce proceedings. A business appraiser’s or judge’s standard of value determines the assets that will be divided, as well as the alimony or child support that may be collected.
Spouses frequently disagree about a business’ value, which necessitates seeking a business appraiser’s or attorney’s opinion. An understanding of the applicable standard of value is paramount to any business owner going through a divorce.
What Is the Standard of Value?
Businesses are infinitely varied in size, organization, and investment. Before appraising the value of a business, a business valuation professional first must define the standard of value.
- Standard of Value-The guidelines, or conditions, used to evaluate the business.
- Fair Market Value-A business’s “fair value” estimates a company’s value to a hypothetical buyer, in a no-pressure circumstance. This is the most common standard of value.
- Investment Value-This valuation attempts to measure a business’ value to its individual investors.
- Fair Value-Similar to fair market value, except fair value is dictated by the court and not an appraiser.
Using the Correct Standard of Value
Each jurisdiction has its own case law and statutes that determine which standard of value to use. If an attorney or appraiser uses the wrong standard of value, the case can be dismissed by a judge.
Knowledge of Case Law
Because the standard of value varies so wildly, attorneys need a thorough understanding of local case law. Many jurisdictions have no set standard of value; the laws vaguely refer to value or fair value.
The Income Approach
When valuing a business in a divorce, appraisers often use the “income approach.” This metric measures a business’s worth based on its projected income in the future. Some argue that this standard doesn’t take into account the fluctuations and uncertainty of business ownership.
The income approach is not without its critics.
What Is Double-Dipping?
It is a common misconception that a business’s potential value in the future should not be used to calculate alimony or a divorce settlement. Some people see a business’s fair market value, or what an investor would pay currently under reasonable circumstances, as the truly equitable division.
A business’s valuation determines whether a spouse can “double-dip.” Double dipping occurs when:
- One spouse collects money from the distribution of the business
- The other spouse’s income from the company is used to calculate alimony and child support
Owners of closely-held businesses often earn higher-than-average compensation in the market.
What Can Be Done With Less Than Half of a Business?
It matters who controls a business. A person with less than a controlling share has less influence over business policies and decisions. Appraisers account for this via discounts for lack of control (DLOC).
In addition to a business’ value, appraisers must consider the overall desirability of the business to an outside investor. When a business is divided in a divorce, the person left holding the lesser portion may not be able to liquidate his or her shares.
Cases like this often prompt appraisers to apply discounts for lack of marketability (DLOM).
Preventing Business Valuation Problems Before They Begin
Divorce is a reality for more than half of American couples. Family businesses can create a difficult situation within the business itself, especially with no plan for equitable division.
Shareholder or Prenuptial Agreements
The simplest time to prevent a business valuation dispute is at the founding of the business. A shareholder agreement can soften a divorce’s impact upon a company. Similarly, a prenuptial agreement can lay out the terms for dividing business assets.
Courts can enforce these agreements differently. Business owners should consult their attorney to make sure the documents are drafted in a way that ensures the equitable division of their assets.