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 of a business in connection with a divorce.
From my experience as a family law attorney, the most difficult and complex part of valuing a business is that it is sometimes true that neither spouse has all the information available to him or her 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 prior to engaging in the divorce you can better able to 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 term. 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 buy, to a willing seller who desires to sell but is under no necessity of selling.
If you are doing any research on your own about learning how to properly value your or your spouse’s business 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 books of the business and subtract all liabilities of the business you arrive at the book value.
When we think about corporations we typically have big companies like Apple, Wal-Mart or Home Depot in mind. These are publicly traded companies whose stock prices are set by an open market of buyers and sellers.
There are corporations that do not sell stock in their business to the public. These are known as “closely held” corporations. For smaller businesses such as these determining the value of the privately held stock can be much trickier. An accountant is often times involved in this process, whose job it is to appraise the business to determine its value.
Is looking only at the book value of a company an accurate way to value the business?
If you are beginning to proceed with a divorce then you may want to discuss with your attorney the options that are available to determine the value of your or your spouse’s closely held business. Beginning with book value, it is likely that he or she would tell you that it is not the best way to determine the value of a business from a stock perspective.
The reason is that book value does not take into consideration sources of value for the business beyond its physical assets. It’s customer list, prospects for growth (future sales) are intangible sources of value that nonetheless should be considered.
For a business that is in the service industry, the book valuation method will almost certainly undervalue the business since its tangible assets are probably rather small compared to other types of businesses.
What your attorney will need you to provide him or her at the outset of your case
Once you and your attorney have a game plan in place in terms of valuing the business in question, you will need to provide him or her with documents and information that an appraiser will need prior to 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 a good place to start. Profit and loss statements divided up in the same manner and going back the same number of years are needed as well.
- A description of the business. What does the business do? How long as the business been operating? What sort of market does it operate in? What are your competitors? A list of your employees, as well as customers and vendors, is helpful as well to paint a full picture of the businesses vital statistics.
- Tax Returns for the past five years. An appraiser will need to see what your current and future tax liabilities are 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 important for the appraiser to know as well.
- 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 to look at since an appraiser can get an idea of how your business is operating now and may operate in the future based on what your business is forecast to achieve.
A forensic accountant will need to be hired by you and your spouse to properly value the business in question. 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 he or she has access to or knowledge of them.
However, it could be that you and your spouse’s attorney agree to simply turn over whatever documents and information that you and your spouse have readily available in order to get this long process started. If the information 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 properly value a closely held business. When you are interviewing attorneys it may be helpful to ask him or her what they think is needed to value the business. 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 business are not that common, if yours is such a case then you will want to make sure that the following rules are followed. Your attorney will be advocating for you and overseeing this process but if you can have knowledge on 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. Goodwill can be difficult to define. If your business builds up a reputation in your community for providing services at a reasonable price then it could be said that your business has strong and valuable goodwill.
On the other hand- what if it is you personally who has been shown to be 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, it is the goodwill built up in the business that is relevant to our discussion. Your life is likely greater 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 business will always see the positive effects of it. However, the goodwill 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 then the appraiser should take it into consideration when valuing your business.
More rules of thumb to value your business to be posted tomorrow
Thank you for your interest in this very important subject in the area of divorce in Texas. Again, I realize that the vast majority of divorces in Texas will not have a small business that needs to be valued. However, for those that do the process of valuing the business will be the most important 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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Law Office of Bryan Fagan, PLLC | Business Owner Divorce Lawyer
The Law Office of Bryan Fagan, PLLC routinely handles matters that affect children and families. If you have questions regarding Business Owner Divorce Lawyer, it's important to speak with a Business Owner Divorce right away to protect your rights.
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