How will the value of your small business impact your divorce?

Let’s imagine a hypothetical situation that could very well mirror your circumstances as you head into a divorce. Your husband is a podiatrist who has grown his practice to the point where he has become quite successful and good at what he does. His podiatry practice is located in an upper-middle-class suburb of Houston. He owns the practice with four other doctors who he has known since his college days. Life is, as they say, good. 

Everything was going great until he cheated on you with his secretary. You found out about the cheating and then he told you that he was going to file for divorce. Here is the problem that you are facing, beyond simply being caught off guard by the revelation that your spouse has cheated on you with his secretary. He earns around $350,000 annually from his business. You earn a nice salary- but not $350,000 or anywhere close to it. You did everything to support his career over the years. You waited tables so he could finish school without having to work or take on an inordinate amount of debt. You stayed home to look after the kids and take care of the house, so it was one less thing for him to worry about. Now he’s divorcing you. 

Now that you are getting divorced you are focused on being able to receive money from your husband’s business to make sure you can keep your head above water until you can find a better job. The job that you have now is fine, but it is not what you want to be doing with your life as you enter the prime of your earning life. Getting a new job may mean either adding a master’s degree to your resume or taking some vocational training. Either way, the job of your dreams is not around the corner. It’s going to take some time to get there. While you work to get to that stage you could use some of the doctor’s office income to be more financially secure in the short term. 

However, once it gets time to discuss the value of your husband’s business, he suddenly tells you that the business is not doing as well as you thought it was. While it is profitable, there are new podiatry practices in that area of Houston that have taken a chunk of their market share. As a result, the trajectory of the business is not as great as it once was. Of course, this is what your spouse is telling you. You don’t completely trust what he has to say but it is something to consider, nonetheless. 

After a day or two of thinking about what your husband had to tell you about the value of his business, you are convinced that he is not being honest with you. You are not exactly an insider into the world of podiatry, but you did a simple Google search and found out that there is exactly one podiatry clinic within 20 miles of your husband’s, and it has only one doctor. The practice cannot be cutting into his five-doctor practice all that much. 

On top of that, you’ve never been able to look at the business accounting statements or earnings statements before. While it would be nice to be able to look at these forms you are not sure if that is possible. No matter what the statements have to say you are sure that your husband’s paychecks have not gone down over the past few years. If anything, they are getting larger and larger with each passing year. Your lifestyle has been maintained, as well. Your husband just bought a new car and you all had been planning a trip for the Spring before the news of divorce had come up. 

Suffice it to say, you don’t know where to turn for guidance currently. You have your suspicions that your husband’s medical practice is doing well but you are not exactly sure. He has told you that the business is not as profitable as it once was. Where can you go to learn more about this situation and how to protect yourself financially from being taken advantage of?

The questions that you are asking to relate to the value of your husband’s small business. Being able to determine the value of a business is one of the most important questions that you can ask yourself in a divorce. In today’s blog post from the Law Office of Bryan Fagan, we are going to discuss what a business valuation is and the different methods to calculate the value of a small business. 

What does it mean to value a small business?

If there is a small business owned by you, your spouse, or both of you that is at issue in your divorce then one of the first things that you will need to do is attach a value to that business. This can be done by an accountant, business appraiser, or business broker. These are individuals who are experts in this field and are experienced in valuing small businesses and finding buyers for those businesses. 

Texas is a community property state which means that the business may be subject to division in your divorce. Your ability to determine a proper value for the business will go a long way towards helping you get a fair share of that business when the divorce is all said and done. Therefore, your spouse is likely telling you that the business is not as valuable as you think that it might be. The smaller the value the smaller the number that would have to be sent to you in divorce proceedings. 

It is not in every divorce case that a small business is valued. Some businesses are little more than a hobby for the person who operates the business. This means that the business does not make any money because any income quickly is paid out in employee salary,  inventory, or overhead. At the end of the day, a business that does not make any money is known as a hobby. Hobbies typically are not worth very much money. 

Or, you and your spouse could have agreed on a premarital property agreement to not take into account the value of the small business when dividing up the marital estate. This could be because you don’t want anything to do with the business, or the costs associated with hiring an expert to value the business are worth more than the business itself. Either way, it is not a given that the small business in your divorce will be valued. 

Profitable businesses, including medical practices, are usually valued in a divorce scenario. As a result, you should consider learning as much as you can about the business valuation process so that you will be able to make decisions for yourself regarding how you want the business to be divided, if at all. 

When you are looking at the valuation of a business what will you see?

Valuing a small business is not as simple as looking at a one-page printout. Rather, when you look at an actual small business valuation that is produced by a reputable expert in that field. It will be detailed because the expert needs to be able to explain himself fully to a judge as to why he is the person who is best suited to help you all determine a value for the business. 

Page number one of the estimate documents will contain the appraiser’s summary of the business value and the factors that were utilized to come up with the value for this business. Most people that come into a divorce to value a small business will use more than just one method to estimate its value. The specific methodology, an explanation for its methods, and then an appraised value will be provided, as well. 

What is the initial step in valuing a small business?

You and your spouse will need to select an appraiser for your small business. Talk with your attorney about who he or she recommends as far as an appraiser of small businesses. Hopefully, your attorney has worked with at least one reputable appraiser in the past. The attorneys with the Law Office of Bryan Fagan have been fortunate to have worked with several great small business appraisers on behalf of our clients. 

An appraiser is simply a person who has the experience, education, and training when it comes to estimating the value of a business. Just like you had an appraisal of your home when you were selling or purchasing it, the same applies to businesses. Whereas in real estate it is somewhat easy to come up with a value for a house due to the sheer volume of comparable homes in the area, it is more difficult to come up with a value for a small business. Not only are there many factors in play when valuing a small business but there is not near the volume of small businesses as there are homes. Think about the podiatry example I listed at the beginning of the blog post. There may only be two or three podiatrists in a 20-mile radius (if that), compared to hundreds of homes. 

A business appraiser will look at the physical qualities of the business like the building that houses the business, whether the building is owned or rented as well as the inventory and state of the equipment being used. Is everything in good condition or is it relatively beat-up and in need of replacement? In addition, the appraiser will look “under the hood” at the financials for your company. How well managed are the bills? Do you owe suppliers or vendors money? What about taxes? Are your clients paying you on time? What sort of setup do you have for collecting on delinquent accounts? These are all factors that need to be considered when coming up with a value for your business. 

Another key factor to consider is the brand name of your business. Is your business is known locally, city-wide, state-wide, or even nationally? These are key factors because there can be a great deal of value associated with brand name recognition and the goodwill associated with the business. Have you ever purchased an item in part because you liked the people who sold the item or because the “mission” of the company was something that you identified with? The same could be true of your business and the product or service that you sell. These are all factors that add to the overall value of your small business. 

When selecting an appraiser, it is critical that he or she has testified in court previously and has prepared appraisal reports for divorce cases. How the appraiser presents information to businesspeople may differ significantly from how he or she should do so with a family court judge. In a battle of expert witnesses, you want your expert witness to be competent and can communicate the issues well. Being able to stand up to cross-examination from an opposing attorney is not a skill that many appraisers possess. 

What kind of information do you need to provide an appraiser with to begin the process?

To start with an appraiser will need a few documents from you or your spouse to begin the appraisal process. Whoever is the spouse most connected to the business will likely be the one who will need to provide the documentation. The longer it takes to turn over these documents the longer the appraisal will take to complete. 

Depending upon when the appraiser is brought into your case you may have had an opportunity already to begin to request these documents through the discovery process. Discovery involves both you and your spouse submitting questions, requests for information, and documents to the other person. These requests are overseen by the court and would need to be responded to within thirty days of receipt of the requests and/or questions. 

Examples of the documents that an appraiser will need are financial statements, general ledgers (accounting), tax returns, bank account statements, balance sheets, business plans, and marketing materials. There are very likely to be additional documents that you will need to turn over to the appraiser that is specific to the type of business that you operate. 

Once the appraiser has all the documents, he or she needs to begin their work, the appraiser will go through the process of determining a value for the business. There are three standard approaches that an appraiser will use to determine the value of a small business- the market approach, the asset approach, and the income approach. We will discuss all three to close out today’s blog post.

The asset approach to appraising a business

The asset approach calculates the value of your business using a formula that involves taking your assets and subtracting your liabilities. The product of that equation results in a value for your business. Tangible assets of your business are your inventory, the building itself if you own it, any other materials that are a part of the building itself, and things around the office or business that you can reach out and touch. Intangible assets are accounts that you are going to be paid for, goodwill in the community, and things of this nature. 

The market approach to appraising a business

The market approach to valuing a business calculates a value by comparing your business to other businesses that have been sold in your area recently. We talked earlier in today’s blog post about how real estate appraisers use the same method to come up with a value for a home or other type of real estate. We already know that this can be a tricky method to use when there are few comparable businesses in your area to compare yours to. 

The income approach to appraising a business

The income approach to valuing a business uses data and specific formulas to project into the future and estimate what your business will be making in future years as well as the profits of the business after expenses are considered. Market conditions and other factors will also be weighed by this formula when estimating the value of your business. 

Overall, most appraisers use each method and then use their knowledge, experience, and training to come up with an overall value for the business. When there are so many moving pieces in play for a business, you need to be able to find a trustworthy appraiser who has done this before and can communicate their findings effectively. 

Questions about the material contained in today’s blog post? Contact the Law Office of Bryan Fagan

If you have any questions about the material contained in today’s blog post, please do not hesitate to contact the Law Office of Bryan Fagan. Our licensed family law attorneys offer free of charge consultations 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 as well as about how your family’s circumstances may be impacted by the filing of a divorce or child custody case. 

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