Determining how to value a closely held or small business during a divorce in Texas can become one of the more complex issues that you face in your case. I am not trying to say that it is a more important subject than determining custody or visitation rights for your kids, but if you have worked long and hard and spent years building up a small business, you want to ensure that it will be taken care of in your divorce. Depending upon a host of factors, you and your spouse may choose to go one direction or another on not only valuing the business but in possibly dividing up its assets, selling it, or allowing one of you to remain as the operator of the business moving forward.
One of the factors that many people do not consider when considering how to sell their business is the fact that value can be found in the actual facility where your business is located, the book value of the business in terms of its inventory, machines, and other tools utilized to operate the business but also in the goodwill value associated with the name of your business in your role in building that business within your community. Some of these assets can be valued easier than others. For example, it is easier to determine the value of a 5-year-old riding lawn mower than it is to determine the value of the business’s name in your community.
How are businesses dealt with in Texas divorce cases?
At least from this standpoint, the method of disposing of a business in a Texas divorce is pretty simple. If you and your spouse want to split up the business, then you only have two options. The first option would be to sell the business to a third party who purchases businesses like yours and then sells off the component pieces or attempts to assemble a management team and run the business him or herself. The other option would be to buy out your spouse’s ownership in the business or vice versa. To do so, there must be available cash on hand, or you must have Community property or other assets available to trade.
In this scenario, the first question that we have to ask ourselves is to determine which of you owns what portion of the business. Keep in mind that Texas is a Community property state. This means that property that came into being during your marriage is subject to being divided up in the divorce. On the other hand, if the property was purchased or acquired before the marriage by you or your spouse, that property could not be divided in the divorce. However, things like profit from that separate property may be divisible. For our discussion today, we need to figure out 1st of all whether or not your business is part of the community estate state or as part of one of your separate estates.
We would need to look at whether or not the business was purchased before your marriage took place or if it was purchased during your marriage with separate property funds. The other alternative would be that you or your spouse could have started your business before your marriage. Therefore, it would be classified as separate property and in a pretty straightforward manner.
As I alluded to a moment ago, even if your business was started before your marriage, there might be elements of the business that are a community in nature. For instance, if your spouse contributed time, community funds, or other business elements, their contributions may be Community property and subject to division in your divorce. Additionally, if your business has increased in value throughout your marriage, those value increases may also be Community property. Finally, any money you and your spouse contributed during your marriage with community funds, such as making improvements on the office or building where your business is located, would also be considered part of the community estate.
What is not especially relevant is whether or not you consider yourself the owner of the business or if your spouse considers herself the owner of the business. While the actual work was done within the business can have some importance in certain regards, the number one factor we need to look to is time and the nature of the funds invested in the business. At one point in time, was the business created? Where did the funds come to start the business? What funds were utilized to build up the business and invest in it while you all were married? To me, these are the most important questions that we need to ask ourselves.
What is the value of the business? How do we decide on value?
Hiring a professional to appraise or value your business is an important and difficult task. Even if you have a rough estimate or idea of what your business is worth or what someone else has told you that your business is worth, it is wise to hire a professional business valuator or appraiser as a part of your legal team. Being able to sift through the financial documents, tax returns, state laws on valuing businesses, and knowing enough about Community property would be 4 characteristics that I would look for in a professional business appraiser.
Between the appraiser and your attorney, you will have in place what you need to present an accurate and fair evaluation of your business for your divorce. However, keep in mind that your spouse will likely have the same team of her own, consisting of different people. Oftentimes the valuation question comes down to the two experts on businesses competing to show why their valuation is more accurate.
Different people could arrive at different values for your business because there are different methods of valuing a business. The first method is called the asset approach. In my opinion, this is the most straightforward method of valuing a business because what you do is take the assets of your business, subtract the liabilities of the business, and arrive at a value. Keep in mind that we’re talking about things that you can put your hands on and things that are more financial or theoretical for both assets and liabilities. Deaths would be an example of an intangible liability, while equity in the land underneath your business would be an example of an intangible asset.
Next, we could consider what is called the market method of valuing a business. From my experience, this is the method that is utilized with the most frequency. It works well when you have a fairly common business such as a restaurant, landscaping business, accounting office, or another type of business that has been sold in relatively high numbers in your area recently. Whatever these similar businesses have sold for will greatly influence the value of your business that is being estimated. Think of it sort of like how a real estate agent would look to market analysis to determine what your house should be sold for as well as what an appraiser would do for appraising your home.
Finally, we need to talk about the income valuation method. This is a much more theoretical approach to valuing your small business because you would take the expected gains to value it in the current day. Profits and cash flow would be projected out into the future, and then you would utilize trends in the business to create a prospectus for what your business may be worth when your divorce is finalized or at a certain date in the future.
What is the goodwill value of your business, and how will it impact the bottom line?
To determine the goodwill value of your business, you must first be able to determine the overall business is value. The goodwill value of your business would result from whatever assets are subtracted from the overall value of the business. The assets that we are curious about here would be intangible assets that are physically present and that are used to operate the business. The difference between these two numbers would be the goodwill value of your business.
Once we determine this number, we can get even more nitty-gritty when determining goodwill value. The reason why is that in Texas, divorce is typical; there is business associated goodwill in personal goodwill. The goodwill associated with your business has more to do with the business’s goodwill in your community. This means that what people in your immediate area and what your clients think about your business matters in terms of this method of valuation.
On the other hand, the personal goodwill of your business has more to do with you or your spouse and your role in operating the business. For example, if you have grown your business in the past decade to be a pillar in the community and you have done things like donated money to charity on a high level, sponsored Little League baseball teams, and generally made a positive name for yourself, then there is a great deal of personal goodwill inherent in the value of your business. I like to call this a “soft factor” in evaluating the business valuation because it is difficult to put a specific dollar amount to this factor. Still, at the same time, it is important, nonetheless.
What could happen to your business in your divorce?
Now that we have talked a little bit about the valuation process that could be a part of your divorce regarding your small business, the next logical question would be what could happen in the divorce as far as your business is concerned. Typically in divorce, most of the issues are finalized in settlement negotiations rather than in a trial. It will probably take multiple attempts to not only value the business but to negotiate on its division, but your case will likely be settled in mediation rather than in a trial.
Ultimately, it would help if you determined what you want to see happen with your business. The reality of a divorce is that what you want to happen may not occur exactly as you see it occurring, but you nonetheless need to have goal sessions with your attorney. That way, your lawyer can communicate your positions effectively in settlement negotiations with your spouse. With so many moving pieces that are a part of this process, it can be easy to lose information in the shuffle. You and your attorney need to be on the same page regarding the valuation question and goals for the divorce in a possible division of the small business.
It is worthwhile to consider whether or not you run the business, whether your spouse does, or if you all run it as a team. This will be a relevant consideration because if only one of you operates the business, it is possible that simply buying out the other non-operating spouse’s interests may be the most logical thing to do. If you all are both an active part of the business and are not interested in operating it separately from the other, then selling the business and dividing up the profits may be the most prudent option to choose from.
Whether or not to sell a business in a divorce is similar in many ways to the decision of whether or not to sell a home as the result of a divorce. Whether or not it is practical, whether or not you all can run a business separately, are relevant questions to ask. If you rely upon the other a great deal to operate the business, it may be best to divide the business, sell it and then use the funds to pay down debt or even open a new business once the divorce is over.
What sort of money is available to buy your spouse out of their share in the business? This is a question that many people in your shoes run into in the valuation process. If you and your spouse conclude that you all should buy out your spouse’s share in the business, you must figure out how to make her whole. Either awarding her a similar amount of community property or creating an agreement where you pay her a certain amount of profit over five or ten years, maybe ideas for you to ponder.
What can you do to prepare for a divorce where a small business?
Being a small business owner, you understand the importance of proper preparation and planning to achieve goals. A person can wander into a divorce but can very frequently find themselves in trouble in that divorce if they do not develop a game plan. As such, I would recommend figuring out early what you want to do with your business in an ideal world. If possible, you should speak to your spouse about the options and see what their thoughts are. You may find that your plans do not differ that much from your spouses. If you could even have a rough outline of an agreement on what to do with the business before the divorce begins, then you will be ahead of the curve.
Next, you should consider finding a divorce attorney who is not only a specialist in Texas family law it has also handled business owner divorces previously. If we apply never handled divorce before, you won’t hire him, would you? By the same token, if the attorney had never handled business, almost divorce, you probably should not put your largest asset into that person’s hands. To learn as much as you can about this attorney, you should sit down and interview them before signing the contract. Ask specific questions about how I would approach the situation and what advice he would potentially have in mind.
Finally, it would help if you worked with your attorney to locate a competent and trustworthy appraiser of local businesses who could be called upon to appraise your business and offer testimony in a trial situation. Your attorney may have a name or two in mind, and then you all should sit down with them to see if they were a good fit. Not only will doing so help you in the long run of your case, but you may also learn something that helps you make better decisions along the way from this expert witness and appraiser.
Questions about the material presented in today’s blog post? Contact the Law Office of Bryan Fagan
if you have any questions about the material presented in today’s blog postcontact the Law Office of Bryan Fagan. Our licensed family law attorneys offer free of charge consultation six days a week in person, over the phone, and via video. These consultations are a great way for you to learn more about the world of Texas family law and how your facts and circumstances could be impacted in a divorce or child custody case.