Divorce is never easy, but the stakes are even higher when a business is involved. Navigating the complexities of asset valuation and property division can feel overwhelming, especially when it involves a marital business. By understanding the nuances that are a part of divorces that involve a business, such as valuation methods and asset division strategies, you can protect your interests and safeguard your business. You should understand that divorces involving a business are different than traditional divorce cases. You should have an understanding of these differences and obtain a lawyer also aware of these nuances in order to help you overcome the challenges that arise when divorcing with a business.
- Determining the classification of a business as marital or non-marital asset is key, and usually your first step, in determining the strategy of asset division during your divorce.
- Professional collaboration with the help of a business appraiser, understanding the business liabilities, employing proper valuation methods, are all essential for the successful navigation of the case when divorcing with a business.
- Financial implications, such as tax issues, acknowledging bad debt, and determining the business’ realistic projected income, should all be considered to minimize the economic impact that the divorce has on the business.
Determining Business Classification: Marital vs. Separate or Non-Marital Property
In divorce proceedings, the distinction between a business as marital or separate property significantly affects asset distribution. Factors that play a role in classifying a business as marital or separate property include the establishment date of the business, contributions from both spouses, and any agreements made during the marriage or before the marriage. The legal distinction between marital and non-marital property can significantly impact the division of business ownership and other assets in a divorce. The reason is because property or business assets that are separate are considered to be non-marital assets and fall outside of the marital estate, which means that the asset is considered to be owned solely by one spouse. This could be the difference between the business having to be sold or dissolved or the business being able to continue to be operational, because these factors influence the divorce judge’s decisions on the division of business ownership. Equally important is the fact that a “buy-out” payment is typically required to be paid by the person awarded the business when a marital business is awarded solely to one spouse in a divorce.
Key Factors in Determining if the Business is Marital or Non-Marital
The classification of the business as marital or as non-marital separate property can significantly sway the business ownership division and the allocation of other assets in a divorce involving a family business. Determining the correct classification of the business also helps ensure that an equitable property distribution occurs and aids in dispute resolution and future conflict prevention. The reason is the classification determines whether the business is awarded to one spouse or divided between the divorcing spouses. This classification hinges on factors such as the business’s establishment timing, the language of the business paperwork and accounts, the contributions made from both spouses or third parties, marital agreements, and the source of start-up capital. A business that was established after the start of the marriage will be likely to be considered a “marital asset,” but not necessarily. If the business existed under a former name prior to the marriage, if the business was a family business of one of the spouses first, and if the business or parts of the business were inherited businesses, are all factors that would lend themselves towards describing the business as non-marital.
Business Valuation Methods: Ensuring Fair Market Value
A precise business valuation is a pivotal objective for divorce cases that involve a business, but a perfect valuation can be nearly impossible. The concept behind divorce is all marital property is valued, which includes marital businesses. The use of a mediator with business expertise can often help bridge the divide between the parties with creative solutions and with persuasive reasoning regarding the valuation of the business. The various methods of determining the fair market value of the business can significantly influence the final property allocation and asset division in the divorce case. The tax implications of a marital business can also influence the direction and methodology for determining the value of the business. Multiple valuation methods can be used to determine the value of the business, and the divorce judge may utilize a hybrid approach that combines multiple various approaches. These methods include the income-based approach, asset-based approach, and market-based approach, in addition to many other approaches to business valuation. Understanding these valuation methods and collaborating with a professional valuator, and other qualified experts, can help divorcing business owners ensure a fair asset division in the divorce process.
The income-based approach values a business based on its projected future earnings. This method evaluates a company’s financial health to assess its future success and worth. The income-based approach involves steps like:
- Estimating the company’s expected future profits and/or cash flow
- Calculating the present value of future earnings
- Considering adjustments and accounting for variables that may affect future earnings
The advantages of using the income-based approach for business valuation in a divorce is that the approach takes into account the ongoing profitability of the business, considers future earnings and income, and accommodates the potential sale of the business. The income-based approach for business valuation may be appropriate for businesses with a strong growth and a history of profitability. The income-based approach to business valuation also can reveal a lack of profitability, it allows for the consideration of industry trends, and it can take market conditions into account. Proponents argue that the income-based approach is preferred, because it delivers a holistic view of the value and potential value of the business.
The asset-based approach values a business based on its tangible and intangible assets. Tangible assets refer to physical assets that possess real value, such as buildings, land, machinery, equipment, and inventory. Intangible assets also possess real value and include elements such as intellectual property, customer lists, digital assets, and the outstanding receivables of the business. The value of tangible and intangible assets combined can help serve as an indicator of the total value of the business, so long as liabilities are applied and other deductions are made from the total of the combined business assets. This valuation method is especially useful for businesses with considerable physical and non-physical assets and for businesses with low or predictable overhead. By considering both tangible and intangible assets, the asset-based approach can offer a more realistic view of the value of the business in the divorce process and help simplify the business valuation process.
The market-based approach to business valuation determines the value of a business by comparing it to similar businesses in the market. This method involves analyzing the performance and financial metrics of comparable companies to ascertain the value that market forces assign to a business under similar circumstances. By utilizing this approach, professionals can evaluate the worth of the business based on industry standards. However, the market-based approach is not always ideal, because it sometimes effectively results in comparing apples to oranges. As such, the market-based approach to business valuation might not be suitable for unique or niche businesses, as comparable market data might be limited or unavailable. If an appropriate comparison is available, the market-based approach can be highly beneficial if the comparable business is a substantially similar business that was recently sold.
Strategies for Dividing Business Assets in Divorce
Asset division in a business divorce can be a complicated and difficult process. How your business is structured can affect how it is divided. Nonetheless, various strategies can assist in ensuring a balanced asset division, such as buyout options, selling the business, or co-ownership arrangements. Each strategy has its pros and cons, and the optimal approach will rely on the specific divorce circumstances and the involved parties.
A buyout involves one spouse purchasing the other’s share of the business, often with tax-free transfers. Defining the value of the business and then reaching an amount for a fair and equitable division from there (often 50%), is the usual and customary approach to determine a buyout amount when divorcing with a business. Typically, the selling spouse is not liable for taxes on the sale of the business, and the buying spouse is required to legally “hold harmless” the selling spouse from all liabilities related to the business. By choosing a buyout approach, one spouse can retain the financial benefit and future control over the business while the other spouse receives a payment for their fare share to walk away.
Selling the Business
Selling the business and dividing the proceeds is another option for divorcing business owners, but this approach comes with its own set of challenges. Some of these challenges include:
- Finding a buyer, which can be difficult
- Reaching an agreement on a sale price, which may be contentious
- Managing the business during the sale process
Despite these challenges, selling the business can be a feasible option for couples who wish to entirely sever ties and fairly divide the proceeds. Often, parties that cannot agree no the value of the business end up satisfied with the sale price as representative of the actual value of the business. Therefore, divorces that involve parties who cannot agree on the value of the business frequently turn to the option of putting the business up for sale. However, the same problem may arise for the same reasons, if the parties are unable to reach an agreement on the sale price. Collaborating with a professional valuator or a business appraiser can help the parties overcome disputes related to their differing views on what the fair market value of the business is actually worth.
Co-ownership arrangements are agreements that divorcing spouses make that allow both spouses to maintain ownership of the business after the divorce. Co-ownership arrangements can result in the former spouses still working together after divorce on a day-to-day basis for the sake of the business. However, co-ownership arrangements typically have one spouse managing the business and the other spouse receiving a percentage of profits. This approach can be beneficial for couples who wish to preserve the business and maintain a working relationship even after their marriage has ended. However, co-ownership may also lead to disagreements and communication difficulties, which can impact the business’s success. This is especially true when both parties remain involved in the business operations.
Co-ownership arrangements are risk, because, simply put, there is a reason that the two spouses cannot stay married. To mitigate potential issues, divorcing couples that enter co-ownership agreements should establish clear boundaries and enter into a formal and legally binding written agreement (such as an operating agreement or shareholder’s agreement) that sets out the terms of their future business relationship. This helps minimize conflicts as both parties continue to work together in furtherance of the best interest of the business. However, since the risks of co-ownership arrangements are impossible to eliminate completely, both parties must be able to work in good faith with one another for this arrangement to be feasible.
Avoiding Common Mistakes in Divorcing with a Business
Business-involved divorce can lead to severe financial implications and other problems. The unpredictable income that is caused by business ownership is difficult enough without going through a strained marriage, but dealing with the same factors when facing a divorce can prove unsustainable. This can create additional stress and can be harmful to productivity and the health of the business.
Evading common mistakes in a business divorce can help insure that you are protected. Such mistakes include overvaluing the business, undervaluing the business or not valuing the business at all, neglecting tax implications, failing to account for business liabilities or intangible assets, failing to consider the income or assets of the business, and not consulting business appraiser or another qualified expert before proceeding with the divorce. By sidestepping these pitfalls, divorcing business owners can safeguard their interests and reduce the long-lasting financial and emotional impact of the divorce.
Parties that are divorcing when one or both parties own a business should be proactive to address and avoid these types of issues and should seek the professional advice of an experienced family law lawyer. Collaborating with a family law attorney and participating in mediation can offer valuable support and guidance throughout the divorce process. Understanding the nuances of business classification, the many valuation methods, and the varying asset division strategies can help divorcing business owners navigate the complexities of a business divorce.
Consult with Business Divorce Attorney Zachary Townsend
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