Settling a divorce case in Virginia, where one of the parties owns a business, can be extremely challenging. Businesses are considered “property” and, just like a house or a retirement fund, are divisible upon divorce. Therefore, in a mediated divorce settlement, the value of a family business must usually be quantified in order for both parties to make informed decisions with regard to which party retains which asset/liability post-divorce.
Q: What does my business have to do with my divorce settlement?
In a mediated divorce settlement, all property (and debt) must be valued in order for parties to understand the actual worth of the marital property that they are dealing with. Businesses are considered property, much like the marital residence, retirement assets, investment accounts, furniture, automobiles, etc. Quantifying the value of a family-owned business in a Virginia divorce allows parties to put that asset on the negotiating table, along with their other assets (and debts), in order to make informed decisions and negotiate fair settlements.
Q: What does “marital property” refer to?
Almost all property (and debt) acquired during the parties’ marriage, with the exception of inheritance and gifts which are made solely to an individual party (not the couple), is marital property. All marital property is subject to division and distribution in a Virginia divorce. This includes businesses which are created during the couple’s marriage.
Also, that portion of a business which was created prior to the marriage, but which substantially increased in value during the marriage due to the significant personal efforts of one or both of the spouses, is also vulnerable to division and distribution in a Virginia divorce.
Though parties who choose to mediate the settlement of their divorce are not required to follow the template of what judges can and cannot do, information about how matters are handled in court is relevant to the settlement process in terms of ensuring informed consent with regard to the terms of the settlement.
Q: Do we have to formally value a family-owned business?
No. In some cases, parties in divorce mediation agree to leave the business out of their settlement negotiations. Instead, they treat the business as the owning-spouse’s “job.” In other words, the business is treated as a source of income, but not as an asset to be put on the table as part of the divisible marital estate.
This is not recommended; but nor is it forbidden. Though it is difficult to make informed settlement decisions when the parties are unaware of key facts – in this case the value of a business which is, in many circumstances, one of the couple’s largest assets – couples do have this right.
Q: Why do some divorcing couples not want to value a family business?
In some situations, ascertaining the true value of a business is close to impossible. Not only that, but the value of a business – particularly one in which there are little if any “hard assets” (e.g., inventory, machinery, commercial real estate, vehicles, etc.) -- is often times more art than science. For some people, “art” is not acceptable when dollars and cents are involved. This problem with business valuations is demonstrated by the wildly divergent valuations that appear in litigated divorce cases where both parties hire their own independent business valuation experts who, after thousands of dollars are spent in expert fees, come up with completely different values for the same business.
Q: Will I have to sell my business or share the day-to-day operations of my business with my ex-spouse?
No. It is rare that a business-owning spouse is required to sell his or her business as part of a mediated divorce settlement. Nor is the business-owning spouse required to share the day-to-day operation of the business with his or her soon-to-be ex-spouse.
Instead, the value of the business is put on the negotiating table along with all of the couple’s other assets (and debts) and the bargaining begins. If a family-owned business has great monetary worth, sometimes a portion of its value is paid out to the other spouse over time in periodic cash payments. Sometimes, 100% of the value of the business is left with the owning spouse, and the other spouse receives more of the couple’s other assets, such as the equity in the house.
Q: How does a divorcing couple place a value on a business?
In a Virginia divorce, courts usually determine the worth of a business based on intrinsic value. Intrinsic value is defined as “what that business is worth to each spouse” . . . which sort of begs the question and not very definitive at all. What courts are looking for is a valuation of the business which considers many factors, not just what the business would sell for if there were an interested buyer. Intrinsic value factors for “soft factors” such as how long the business-owner plans on owning the business and when he or she plans on retiring.
Within the process of determining intrinsic value, there are three common valuation models that are considered. Differing weight is applied to each model, depending on the valuation expert and the business being looked at. All of these models have subjective qualities of their own.
- The income/excess earnings approach compares the business owning spouse’s income to the average income of someone in their peer group. If the income is greater than that of their peer group, those “excess earnings” are appropriated to the value of the business itself. This method is based on projecting the future stream of “excess earnings” of the business owning spouse.
- The asset valuation approach uses the assets of the business as a key determinant of its value. Unless there are tangible assets (e.g., trucks, equipment), there is often not much to value with this approach.
- The market value (aka fair market value) approach looks at the selling price of similar businesses to determine the intrinsic value. Sometimes discounts are applied to account for such factors as lack of marketability and lack of control. how much longer will they own the business, the level of compensation they will continue to earn, when they plan on retiring/exiting the business among many others.
To establish an intrinsic value of a business, a business valuation expert is required. These can be Certified Valuation Analysts (CVA) or, in some cases, Certified Public Accountants (CPAs) who specialize in valuing businesses.
Q: How does “goodwill” fit into the value of a business?
In the context of business valuations for a divorce, “goodwill” is a huge and confusing topic – another “monkey wrench” in an already complex arena. In a nutshell, goodwill is an intangible asset of a company, that adds value to that business. Goodwill is often used by businesses to attract clients and customers, utilizing personal or professional factors to increase their revenue. In a Virginia divorce, the law further divides goodwill into “personal goodwill” and “professional goodwill.” Personal goodwill not divisible; professional goodwill is divisible. For more information on the impact of goodwill in a Virginia divorce, see my article on this topic “What is Business Goodwill in a Virginia Divorce?” (blog to be published one week following publication of this blog).
Q: Do we have to hire an expert to value a family-owned business?
No. Though not usually recommended, some divorcing couples come up with their own value for a family-owned business based on one of a myriad of business valuation formulas that are available. These fairly simple calculations require a variety of specific bottom-line numbers to be plugged into the formula. If the couple is savvy in finance and/or understands the comparison of their business valuation method to a professional valuation, they may choose this route and save themselves thousands of dollars in expert fees.
Q: How do mediators handle business valuations?
In mediation, divorcing parties have a choice as to whether or not each of them wants to formally value a business. They need to understand the concept of valuation as it relates to divisible marital property; but parties have a right approach the valuation of a spouse’s business as they see fit. There are three primary ways of dealing with this issue in mediation:
- Choose one agreed valuation expert (not two) and, as if often the case, also agree on the particular valuation method to be used (couples in mediation are not required to use the Virginia court preferred “intrinsic valuation” model);
- Choose an agreed business valuation formula (see Q&A immediately above) and share the necessary financial documents to plug into the formula (e.g., P&Ls, Balance Sheet, I&Es, etc). Some couples have an independent CPA review the financial documents for “holes” prior to completing their computations. Some divorcing couples also have their CPA weigh-in on the choice of formulaic valuation and have that CPA actually do the calculations for them.
- Treat the business as a “job” (i.e., no valuation is done). This is fairly common in micro-businesses where the owner is the business and, in addition, where his or her income will also be the basis for spousal support.
Valuation of a business in divorce can easily become a complex and confusing process. Utilizing a divorce mediator, rather than going through court, helps to simplify the process. Instead of subjective decisions handed out by a judge, parties themselves can discuss the value of the business, and consult with an expert who works towards agreed compromises. A divorce mediator will sit down with both parties and discuss differences until a solution is found. If you are searching for an experienced divorce mediator who can assist with these problems, contact Robin Graine of Graine Mediation at 571-220-1998, or by email at [email protected].
By Steven Seril, Mediation, Marketing & Research Assistant
& Robin Graine, JD, CDFA
