Business Valuation Overview
When a marriage ends, the spouses will need to divide their marital property. This can be a complex process, especially when it involves an interest in a business. Experts often are required to assess the value of the business, and its tangible and intangible assets. Tangible assets include cash, inventory, equipment, and other physical items related to the management and operation of the business. Intangible assets might include goodwill, rights assigned by contracts, and rights to trademarks, patents, or copyrights associated with the business.
Since the appraisal of assets is a subjective process, each spouse often chooses a separate expert to present the argument that best suits his or her goals. These experts will present their findings to the court as testimony in a divorce proceeding. The judge then must decide which expert’s approach is more convincing in this specific situation, unless the spouses agree on a method that satisfies both of them.
Approaches to Valuing a Business
There are three main ways to value the assets of a business during a divorce proceeding: the income approach, the asset approach, and the market approach. Any of these approaches may be the best way to value a certain business, but each of them has important flaws to recognize.
The income approach tries to assess the anticipated economic benefits of a business while discounting for the risk that those future benefits will not be received. Experts can examine past financial data from the business and make adjustments to project what might happen in the future. A controlling shareholder of a business may get more compensation than the open market would provide, so the expert will need to set an appropriate amount of compensation for that person’s position and responsibilities. This approach is the most commonly used way to value an interest in a private business.
The asset approach consists of assigning a total value to the tangible and intangible assets of a business and assigning a total value to its liabilities. The liabilities are then subtracted from the assets. This can be challenging because many intangible assets are not easily valued and may not even be recorded. Furthermore, some assets may not have the same value to a business that they would in an open market. This method is most effective if the business is very small or based around investments. When a business has not yet accumulated significant goodwill, the asset approach can be especially accurate.
Finally, the market approach tries to compare the business that must be divided to similar businesses that have been sold. Similar to real estate appraisals, this method is based on the idea that recent transactions are the best way to evaluate what a business is actually worth in the current market. Despite its intuitive logic, the market approach is not always easy to apply. Many small, privately held businesses are not truly comparable to large public companies in terms of sales and profits. Transactions involving those businesses thus have a much broader sweep and may cause an expert using this approach to value a privately held company too highly.
Much can be at stake in valuing a business during a divorce proceeding. The business often is the most valuable component of the marital property being divided between the spouses. You should make sure to seek the legal and other professional guidance that you need to protect your rights to your interest in the business.