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Three Pressing Issues for Business Owners Going Through a Divorce

The most significant asset in a marital estate is often the family business.

Splitting up a marital estate can be a long and complicated process, particularly if one of the assets includes a privately owned business.

Some common issues include:

  • How much is the business actually worth?
  • Do you need to be concerned about the issue of “double dipping” when considering the valuation of a business and the money spouses owe in support obligations?
  • Is the spouse that owns and operates the business deceptive when it comes to reporting his income?

How much is the business actually worth?

There are three methods used to value a business: the asset, the market and income approaches. All of these methods start with an analysis of the company’s financial statements. But discovery shouldn’t stop there, especially for spouses who aren’t involved in the day-to-day business operations.

Valuation experts should be given equal access to financial records and opportunities to tour the company’s facilities and interview management. Inadequate discovery can cause an expert to miss critical information and possibly lead to an inaccurate conclusion of value.

If the business interest was owned prior to the marriage, it might be appropriate to include only the appreciation in value over the course of the marriage. This of course depends upon the facts of the case and relevant state law. Estimating appreciation in value requires a comparison of the current value of the business as compared to its value at the date of marriage.

How do you reconcile the valuation of the business, its potentially equitable distribution and support obligations?

In certain instances you may need to adjust the business’s value from the marital estate relating to the concept of “double dipping.” This may occur when a spouse receives double recovery for a single asset. For example, courts in some states have decided that it’s inequitable for a spouse to receive maintenance payments based on his or her spouse’s future income, in addition to a share of the value of a business. In other instances, the value of the business may be determined with a cash flow that is net of a reasonable officer’s compensation to avoid double counting. In each instance you need to consider your individual state law.

Is the business owner deceptive when reporting income?

A controlling shareholder spouse may try to hide income or assets to achieve a more favorable divorce settlement. Downplaying assets and income (or, conversely, exaggerating liabilities and expenses) can lead to lower business valuations and reduced payments for child support and alimony—unless a valuation expert identifies the anomaly and makes an adjustment to record the value of the missing or inaccurate item(s).

Reasonable “replacement” compensation, based on the market value of the owner’s contribution to the business, is a common adjustment that’s made in divorce cases. Additionally, some business owners try to deduct their personal attorney’s fees or expert fees as business expenses. Running these and other personal expenses through the business not only reduces the value of the business interest, but it could also expose the non-controlling spouse to an IRS inquiry.

Other adjustments may be needed to normalize the income stream to benchmark the subject company against comparable companies. Examples include adjustments for nonstandard accounting practices, such as cash-to-accrual basis of accounting changes, and for nonrecurring income or expenses from, say, a discontinued product line or sale of a nonoperating asset.

Looking at the big picture

The most significant asset in a marital estate is often the family business. A fair resolution hinges on an accurate valuation of same. That can be achieved by working with an experienced valuation expert who understands how courts handle challenging divorce issues and the application of sound valuation concepts.

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