I recently wrote about the options for dividing, disposing of, or continuing to operate a business that was owned jointly by a divorcing couple. But, that’s just one of many scenarios that may arise when a business or interest in a business is at issue in a divorce case.
Here are the key questions in play when one spouse wholly or partially owns the business:
Is the business a marital asset?
The general rule is that an asset acquired during the marriage is a marital asset, and an asset one party owned prior to the marriage is not–even if that asset has increased in value during the marriage. In the case of a business, the question may be more complex. For example, suppose marital assets were invested in the business during the marriage. In that case, the non-owner spouse may be entitled to a share in the value of the business even though the owner spouse had the business prior to the marriage. But, determining exactly what share is appropriate can be complicated.
Is there a prenuptial agreement or other legal documents that would dictate how the business is treated?
Suppose one partner owns a business before the marriage. In that case, it’s generally good practice to enter into a prenuptial agreement making it clear that the business is to be treated as separate property. While a prenuptial agreement is probably the most common type of contractual limitation on a spouse’s interest in a business, it’s not the only possibility. For example, if the owner spouse is in a partnership or closely-held corporation with others, the non-owner spouse may have been asked to sign a waiver of interest in the business.
These types of agreements, when properly drafted and executed, can protect the owner’s spouse. But, it’s important to review these documents with your divorce lawyer as soon as possible. Under some circumstances, a prenuptial agreement or other contract or waiver may be subject to challenge.
What is the business worth?
If the business is wholly or partly considered a marital asset, you will need to put a dollar value on the business. With few exceptions, this will require hiring an expert to appraise the business. Often, each party will appoint a separate appraiser. If the two values are close together, the parties may agree on an amount–stipulating to the value of the business saves time and money, so small differences usually aren’t worth fighting over. If the two appraisals differ significantly, it may be necessary to have both testify and present evidence to the court in support of their valuation.
Valuing a Business in Divorce
Determining the value of a business requires a deeper dive than most business owners realize. Even if the business has recently been appraised for other purposes, the value assigned may not be applicable in a divorce case. For example, suppose a business has recently received a valuation for an IPO. In that case, the stated value may have been increased by a high level of interest in shares in advance of the offering. So, you will almost certainly need a fresh appraisal.
The date of valuation is also significant. Generally, Illinois courts consider the valuation as of the date of dissolution.
While the general standard for valuing a business in a divorce is to determine the business’s fair market value (FMV), there are multiple approaches to making that determination. These include:
- Market Comparison: This method is similar to the “comparable sales” approach to valuing real estate, in that it looks at similar businesses to arrive at a value. Market comparison isn’t often used in divorce cases, in part because there is often a shortage of truly comparable businesses to look at.
- Asset-Based Valuation: Asset-based valuation is essentially a balance-sheet appraisal. This method assesses the value of the business’s assets and sets them off against any outstanding liabilities. This method is often useful when business operations are terminating since, in that situation, assets will typically be liquidated, creditors paid, and the balance available for distribution. However, both parties should be aware that liquidation in divorce is likely to mean reduced value for both parties.
- Income Approach: Income-based valuation considers future earnings, often discounted to present value. This method may present challenges as the parties may disagree about the validity of projected future earnings and are most useful with a long-term business that has seen stable trends over time or with long-term contracts that make future earnings more predictable.
The best approach to arriving at a specific business value depends on a variety of factors and may be an issue the spouse’s experts disagree about.
Of course, this is a very high-level overview of the issues involved in valuing a business for property distribution purposes. Suppose you own a business and are considering divorce. In that case, it’s in your best interest to speak with an attorney experienced in divorce cases involving business ownership before you take any action. If your spouse has already filed, you’ll want to talk with an attorney as soon as possible.
A consultation with one of our experienced complex divorce attorneys is a great place to start.