If you or your spouse own a business and are now contemplating or beginning a divorce, then today’s blog post has been written with your family in mind. It is a challenge to determine the fair market value in connection with a divorce.
From my experience as a family law attorney, the most complex and challenging part of valuing a business is that it is sometimes true that neither spouse has all the information available to them that is needed to provide a proper valuation.
With that said, if you can know some of the more critical information about valuing a business before engaging in the divorce, you can better make decisions that benefit you in the years to come following your divorce.
Learning the terminology associated with valuing a business
At the outset of today’s blog post, I used the term “fair market value” before we had a chance to define the time. Fair market value means the amount that would be paid in cash by a willing buyer who desires to buy but is not required to purchase to a willing seller who wants to sell but is under no necessity of selling.
If you are researching how to value your or your spouse’s business correctly, you may also come across the term “book value.” The book value of a company is the value shown by the books of a business. If you take the total value of the assets as shown by the business books and subtract all company liabilities, you arrive at the book value.
We typically have big companies like Apple, Wal-Mart, or Home Depot in mind when we think about corporations. These are publicly traded companies whose stock prices are set by an open market of buyers and sellers.
Some corporations do not sell stock in their business to the public. These are known as “closely held” corporations. For smaller companies such as these, determining the value of the privately held stock can be much trickier. An accountant is often involved in this process, whose job is to appraise the business to determine its value.
Is looking only at a company’s book value an accurate way to value the business?
If you are beginning to proceed with a divorce, you may want to discuss with your attorney the available options to determine the value of your or your spouse’s closely held business. Beginning with book value, it is likely that they would tell you that it is not the best way to determine the value of a company from a stock perspective.
The reason is that book value does not consider sources of value for the business beyond its physical assets. Its customer list and prospects for growth (future sales) are intangible sources of value that should be considered.
For a business in the service industry, the book valuation method will almost certainly undervalue the company since its tangible assets are probably relatively small compared to other companies.
What your attorney will need you to provide them at the outset of your case
Once you and your attorney have a game plan to value the business in question, you will need to provide them with documents and information that an appraiser will need before beginning their evaluation. In no specific order those documents are:
- A balance sheet for the past few years broken down into three-month increments. At least three years’ worth of balance sheets is an excellent place to start. Profit and loss statements divided up in the same manner and going back the same number of years are also needed.
- A description of the business. What does the company do? How long has the business been operating? What sort of market does it work in? What are your competitors? A list of your employees, as well as customers and vendors, is helpful as well to paint a complete picture of the business’s vital statistics.
- Tax Returns for the past five years. An appraiser will need to see your current and future tax liabilities and if the business has fallen behind on its taxes.
- Information on employee benefit plans health insurance coverage, including the annual costs of each. If the company offers profit sharing or stock options, this knowledge would be necessary for the appraiser to know.
- Finally, if your business does any internal forecasting for future finances, then those should be provided to your attorney as well. This is always interesting since an appraiser can get an idea of how your business is operating now and may use it in the future based on what your business is forecast to achieve.
A forensic accountant will need to hire you and your spouse to value the business in question properly. The costs of this accountant will likely be split between both of you in some manner consistent with your ability to pay an expert such as this.
The discovery process would likely allow for all of these documents to be requested from your spouse if they have access to or knowledge of them.
However, it could be that you and your spouse’s attorney agree to turn over whatever documents and information that you and your spouse have readily available to get this long process started. If the tip becomes hard to come by, for whatever reason, your attorney can seek alternative methods of obtaining these documents through the courts if necessary.
Your attorney should know what documents are needed to value a closely held business properly. When you are interviewing attorneys, it may be helpful to ask them what they think is required to respect the trade. During the middle of a case, your attorney and your spouse’s attorney will likely agree on a deadline and method for turning over documents to one another.
Rules of the road for properly valuing a closely held business
While those divorces that need to have a forensic accountant value a company are not that common, if yours is such a case, you will want to make sure that the following rules are followed. Your attorney will advocate for you and oversee this process, but if you can know this subject, at least to a certain extent, you will be better off for it.
Utilizing goodwill as a part of what your business is worth. Friendship can be challenging to define. If your company builds up a reputation in your community for providing services at a reasonable price, then it could be said that your business has substantial and valuable goodwill.
On the other hand, what if you are personally a valuable entity and someone who personally has a large amount of goodwill built up in your community? Which type of goodwill should an appraiser take into consideration when determining the value of your business?
Because the business itself is what is in question here, the goodwill built up in the company is relevant to our discussion. Your life is likely more significant than your businesses’ (or we hope so, at least).
You may end up selling your business or liquidating it. Therefore, any personal goodwill you have does not mean that the company will always see the positive effects. However, the friendship that your business has developed is seen to be more permanent.
The bottom line is that your reputation as a business owner might go away if you decide to sell the business. Your businesses’ general reputation around town is seen as more permanent and should be seen as an asset by a potential buyer of your business in the future. As long as that goodwill can be translated into dollars, the appraiser should consider it when valuing your business.
More rules of thumb to value your business to be posted tomorrow
I appreciate your interest in this vital subject in the area of divorce in Texas. Again, I realize that most divorces in Texas will not have a small business that needs to be valued. However, for those that do, the process of valuing the company will be the most crucial aspect of your case after any issue relating to your children, most likely.
Questions about this subject or any other in family law can be addressed to the attorneys with the Law Office of Bryan Fagan, PLLC. If you would like to meet with one of our licensed family law attorneys, please do not hesitate to contact our office today. A free-of-charge consultation can be had at our office six days a week.
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