During the past few days, we have spent some time discussing how your family business may be valued in the event you get a divorce. Whether you are leaving, your spouse is leaving or you are just plain putting it up for sale, it is important that you learn how value will be attached to the business you put your heart and soul into the opening. Many divorces turn on how the value of the business is arrived at and how each party wants to divide those dollars in a sale.
That's not to say that it is the most important part of a divorce. Obviously, if you have children then they are at the front of the line, in terms of importance. But, I have been helping people with divorces long enough to be able to tell you that if you are a business owner, your business comes next. Even if you have an accountant, a team of advisers and your spouse "runs the books" you still need to be aware of what methods are utilized in Texas divorces to determine the value of a small business.
If you haven’t done so yet, I recommend that you go back and read through the past few blog posts from the Law Office of Bryan Fagan. We have done our best to break down all of the major issues that you are likely to encounter when it comes to handling a small business in the context of a divorce case. Today we will continue to do that by discussing the different methods that your judge may use to value your small business.
Adjusted Book Value
Now, I’m going to warn you, what you are about to read may seem like a mini-semester in an accounting course. For that, I apologize in advance. I’m fond of telling clients that sometimes I need to give you a “broccoli and cauliflower” answer instead of a “candy and cookies” answer. Translation: not everything I tell you is going to give you the warm and fuzzies. Sometimes we just have to put aside entertainment and just talk turkey.
The adjusted book value of a business is the assets of that business (ones that you can touch) that are appraised and then given a value unto themselves. The liabilities of your business are calculated next and then subtracted from the value of those assets. This method tends to spit out a pretty conservative estimate of the value of your business.
The reason, best as I can tell, is that if you look around your office it isn’t likely that you own a bunch of really expensive equipment. In 2019, it’s more likely that the value of your business lies in its earning potential. True, if you own a warehouse or a printing press then you may own some expensive stuff. However, if you are a designer, your laptop and the software on that laptop may be about the only things you own to run your operations.
Looking at income
If a person buys your small business he or she is looking to make money. This may be the understatement of the century but it is important for the following reason. When an appraiser judges your business by looking at an income approach then he or she does so base on how much money the buyer will receive over a given period of time. An appraiser is trying to estimate how much income your business will generate in the future. Next, a decision will need to be made as to how much an investor would be willing to invest in order to get their hands on that stream of income.
A market approach to valuing your business
In yesterday’s blog post we introduced the topic of a market approach to valuing your small business. This approach basically looks to see what other businesses like yours have recently sold for as well as what the sales have been like within your business. Any of us who have sold a home before are aware that a home appraiser will look at local sales of other homes
I will point out again that the market approach to valuing a small business is not all that trustworthy in the eyes of most judges. One of the big reasons for this is that there may not be many small businesses in your area that do what you do and have been sold recently. The appraiser may need to pull data from places that are far away or don’t really do what you do in order to come up with a value estimate.
Who will serve as your appraiser?
If you get into a situation where an appraiser needs to be hired to value your business, it is likely that he or she will need to possess specific qualifications and experience to serve in that capacity. For instance, if you and your attorney want to hire a Certified Public Accountant, he or she should be certified in the State of Texas and should have experience in the real world valuing businesses.
Ensure that your attorney is doing their due diligence to locate the best appraiser that he or she can locate. It is probable that your attorney will ask around the courthouse to see which appraisers are well thought of and do a diligent job. Obviously, the cost is a factor and availability is important as well. I have been around divorce cases that have dragged on and on because getting an appraiser involved took a very long time.
How will your divorce conclude, as far as the small business is concerned?
There are really only three conclusions that a judge can reach in relation to your small business. It may surprise you that this is the case, considering that we have spent the better part of a week going through the different methods that can and will be employed to determine the value of your business. However, once we have a value there are fewer variables in place as far as determining the outcome of your case.
First off, and this is not one that is common, you and your spouse could both remain working at the business even after the divorce has concluded. Some people are wired in a way that even though they can't stand living with another person, their opinion changes when it comes to working with them. If you can stomach the thought of working with your ex-spouse on a daily basis or don't have a physical office location that requires that you be physical with your ex-spouse this can work even better.
Next, your business could be sold and the profits from that sale divided up between you and your spouse. You are divorcing your spouse for a reason and likely don't want much of anything to do with that person again. True, if you have children there will always be a relationship there to an extent, but for the most part, you want that all to be in the past. Selling your business may turn your stomach in a lot of ways, but it may also be the right thing for you and your family.
Selling your business and walking away with your equity stake can allow you to start over fresh as a single person. As we have discussed previously, it can be difficult to find a buyer for your business, however. If you live in a large metropolitan area like Houston, the sheer volume of people we have living here can mitigate that concern, however.
The other option would be to have one of you keep the business and run its day to day operations on your own, while the other is bought out of whatever their share in the equity is. This could be a win-win for everyone. If you really want to keep running the business you can do so, while also not having to worry about the involvement of your ex-spouse. Your ex-spouse can be released from their obligation to run the business and can have some seed money to start their own operation if he or she chooses to do so.
Where does the money come from to buy your spouse out of their share in the business?
Sometimes the equity in your marital home is utilized in order to pay the buy out on the business. This offers potential problems if you need that money in order to cash flow improvements to the home, the business or simply to pay attorney’s fees. Stocks, mutual funds, bonds and other items like this may be the most preferable to pay out a spouse’s portion of their ownership stake in the business. The easy nature of these funds as far as converting them to cash is appealing, as is the fact that the taxes on your transferring ownership to your spouse are minimal.
Is the business community property or separate property?
To this point, we have been writing as if the business in question is one that both you and your spouse play a central role in its operation. However, it could be that it is only you that has taken part in the creation and daily running of it. If your business was started during the course of your marriage it will likely be community property. You would need to prove that the business was started with separate property funds if you intend to prove that it is your separate property.
However, we can get into murkier waters if community property money was utilized in order to maintain the business or contributed to its day to day administration. If this is the case for your small business, there are likely financial considerations to make. This is true even if your spouse did not come into work a day at your business, or knows nothing about it. The same is true for your community property income from that job, after all. I have had many clients who have told me that since they have separate bank accounts that their income should not be considered part of the community estate. All I can say is that is not how the law works in Texas.
Your business' value can be computed as of the day of your divorce, the day your divorce was filed or your separation date. Next, the appraiser will need to select the valuation method that he or she believes will result in the fairest value number and be one that the judge will accept.
As with most anything in life that you encounter, finding a good appraiser for your divorce will cost you time and money. You’ve already hired an attorney to represent you so this will help you. Rely on your attorney’s experience but do not take what they have to say as being a Gospel truth. Learn as much as you can, ask questions and never proceed with any decisions until you understand the what’s and the whys of the decision being made.
Questions about selling your business in a divorce? Contact the Law Office of Bryan Fagan
If you have any questions about the material that we have covered today please consider contacting the Law Office of Bryan Fagan. Our licensed family law attorneys represent clients across southeast Texas who know their way around a business owner’s divorce case. We pride ourselves on our commitment to the client experience and achieving results inside and outside the courtroom for our clients.
Contact us today in order to set up a free of charge consultation. A consultation is free of charge and allows you to ask questions and receive honest feedback about whatever circumstances you may be facing. We know that you may be unsure of what to do next when it comes to a potential divorce, and we are here to help provide you with the sort of honest and fact-based guidance that is hard to find these days.
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