For many married business owners, the business is both the most valuable and most illiquid asset in the marital estate.

Business owners, of course, are not excluded from these daunting statistics. For many married business owners, the business is both the most valuable and most illiquid asset in the marital estate. Therefore, it is reasonable to assume that if owners divorce, the business will be an asset that will spark substantial controversy and conflict between the divorcing parties.

Who Should Value it?
If the business is to be included in the dissolution of the marital estate, it is highly advisable for the business owner to have a business valuation performed by an appraiser who is:

• Independent – An attorney is an advocate of the client, whereas an appraiser is only an advocate of the business’ value. Therefore, having your CPA (or another individual with whom you already have an existing personal or professional relationship) perform the business valuation is a big no-no. Opposing legal counsel (for the non-owner spouse) can easily dispute the credibility and objectivity of the business valuation report. Moreover, any appraiser you have an existing relationship with and who knowingly accepts such an assignment is bordering on a violation of professional ethics.

• Certified – An individual can have an alphabet soup of letters after his or her name, but at least one set of those letters should be from a recognized professional business valuation organization. Many courts have disallowed valuations performed by uncertified individuals. Hiring an uncertified appraiser not only wastes your time but your money, as well.

• Experienced – Unfortunately, it’s not enough to hire an independent, certified appraiser. You must also hire one who has substantial valuation experience in your company’s industry. Experience is critical and, typically, can make or break the validation of the appraiser’s value opinion, especially if your company operates in a niche market.
  

What Is Valued?
The amount (or percentage) of ownership to be valued will guide your appraiser in the valuation analysis and application of the appropriate valuation methodology. Typically, a 51 percent or more business ownership represents a controlling interest and is worth more than one that is of a non-controlling nature (50 percent or less). Depending on the particular state case law, a valuation discount for minority ownership may apply.

However, if the ownership of the company is 50-50 between co-owner spouses, a non-controlling premise may not apply. In this case, the individual 50 percent ownership may be recognized as a controlling interest due to the familial relationship of the parties involved.

Your appraiser should be very familiar with the relevant state case law. Many states mandate a particular standard of value be utilized valuing closely held stock or ownership for divorce purposes. For most tax matters concerning the IRS, the standard of value is fair market value; i.e., a hypothetical willing buyer and seller. However, for divorce purposes, the standard may not be fair market value. The value might be referred to as “divorce value” or “marital estate value.”

The standard of value may also impact the court’s allowance of valuation discounts, such as marketability and minority ownership discounts. Further, the particular state case law may specify the separation of corporate goodwill and personal goodwill. This is particularly pertinent to professional service companies, such as engineering firms, accounting firms or healthcare practices.

The entity structure of your company is also relevant. A hotly contested topic in business valuation is the tax-affecting advantages and disadvantages of C corporations vs. those of pass-through entities, such as S corporations and limited liability companies. Although there are different schools of thought on the issue, the taxation of business earnings is controversial because it may make a material difference in the value of your ownership interest. If your company is taxed as an S corporation, your appraiser may use the S Corporation Economic Adjustment Model, for example, to ascertain the effect the income tax treatment the pass-through entity has on the value of your pro rata ownership.

Impact of Divorce?
Aside from the obvious emotional impact a divorce may have on you, the financial implications on your business can be overwhelming and more than anticipated. However, funding the marital settlement can place a financial burden on your business if you do not have sufficient personal liquidity. Supporting the settlement without interrupting business operations typically requires sufficient cash on hand, readily available liquid assets or another type of funding vehicle such as a business loan.

Some common mistakes an owner facing divorce may make in relation to the business are:

• Running personal or non-business related expenses through the business
• Blatantly neglecting operations
• Selling off or destroying business-owned assets
• Dramatically depleting profits or cash on hand
• Ceasing operations

Oddly enough, these tactics may have zero to little effect on the business’ value, and it is recommended owners avoid extraordinary actions or business decisions outside the company’s day-to-day operations during this time. First, the court and opposing counsel will probably be savvy enough to recognize the actions of possible self-inflicted sabotage. Secondly, the court will typically specify a valuation date, which could be the date of separation or another specified date, and the value of the business may be based on historical operations up to that date.

Lastly and most importantly, anomalies and extraordinary events may be “normalized,” meaning the appraiser will recast the financials to reflect the normal course of business. Nevertheless, an appraiser can bring sanity to divorce business valuation situations. Therefore, as a business owner, don’t make the mistake of choosing an inexperienced appraiser.

Be Prepared
Although it may seem a bit pessimistic to suggest planning for divorce, the consequences of not planning for any untimely life event, whether it is divorce, disability or death, can have a devastating financial impact on your business. Regular business valuations allow you to proactively care for the viability of your business investment and therefore ‘anticipate’ an untimely event requiring immediate liquidity.

However, if planning isn’t an option and the unexpected event is already upon you or your partner, be smart in your selection of an appraiser. A business owner contemplating marital dissolution should always seek professional legal advice to determine the scope of the valuation engagement and the necessary course of action. Due to the variances in the appraisal process by state, company and personal circumstances, the business appraiser should work closely with your designated counsel in defining the focus for the valuation process. Not doing so wastes precious time and money.

Erin Hollis, AVA, CM&AA, MBA, is director of valuation services for Accountancy Associates LLC, a related company of International Profit Associates and Integrated Business Analysis (IPA-IBA). For further information, call 847-495-6786 or visit www.ipa-iba.com.