Valuing a Business in a Divorce

During a divorce proceeding, each spouse’s separate property is awarded to them. Property that is determined to be community property is divided evenly between both spouses.  That said, it is not uncommon for a spouse to bring a separate property business into the marriage.

When this happens community labor or community funds may be used to increase the value of the business.   Which leads to the question of whether the “community” is entitled to share in the increased value of the business.

Over the years, the Nevada courts have developed two different methods for valuing how much of the business is community property.  The two methods derive from California case law which established guidelines for valuing a business during a divorce proceeding.  The court is charged with determining the value of the business and how much of the value is separate property and how much is community property.   The separate property value is not divided, while the community property value is divided evenly between the spouses.

The Pereira Formula

One method of apportionment the courts use is known as the Pereira formula.  This formula derives from a California case, Pereira v. Pereira, 156 Cal. 1 (1952). The Pereira formula is commonly used when the increase in value of the separate property business was primarily the result of a spouse’s labor and not a result of outside market forces.

Among the most common business categories that are assessed using Pereira include; small retail owners, lawyers, dentists, doctors and accountants.  These types of businesses usually grow because of the work of the professional and not because of outside trends or market forces.

First, the court will determine the value of the business at the time the marriage started. Then, the court will calculate a reasonable rate of return to that value and allocate that as the spouse’s separate property. Anything above that figure will then be considered community property.

In most cases, Pereira is directly applicable to small businesses and professional services in which the owner has a direct influence on income generation and the business operations in general. It is the preferred method when the owner’s efforts were the significant reason the business has grown.

The Van Camp Formula

When the increased value of a separate property business is primarily due to outside market forces and not the sweat equity provided by a spouse, the court will often apply the Van Camp formula, which derives from the California case, Van Camp v. Van Camp, 53 Cal. App. 17 (1921).

Van Camp is usually used with a larger business that grew because of something other than a spouse’s labor.  A business that grows because of a market trend, or utilizes new technology, or invests in research or development of a product have grown because of market forces and not the spouse’s labor.   Among the types of businesses likely to apply Van Camp include real estate holdings, manufacturing, technology, software, and internet operations.

Using the Van Camp formula, the court will calculate and attach a fair salary the spouse should have received while working for the business.   The yearly salary is multiplied by the years married.   This amount represents the community property from the business.  The community household is entitled to this full amount.  If the community household has not received this amount over the marriage, then they are owed it.   The remaining value of the business is separate property.

Which is Better; Periera or Van Camp?

Determining which valuation method is best will usually depend on what you are looking for in a settlement. Generally speaking, the Pereira method for valuation is of greater benefit to the community, whereas Van Camp offers greater benefit to the owner of the separate property. The decision as to which method to use will depend on the influence of the non-owning spouse in the development and growth of the business. Pereira is used primarily when the appreciation of the business’ value is directly related to the amount of effort and skill shown by its owner.  Pereira assumes that appreciation during the marriage is due to the physical efforts of the spouse and therefore is mostly community property.

On the other hand, Van Camp is used when the appreciation of the business’ value is primarily attributable to factors built into the business.   Under Van Camp, “reasonable compensation” is given to the community.  The rest of the business value belongs to the spouse who owned the business prior to marriage.

The court is free to choose whichever approach the judge feels is most appropriate.  The court can even look at both approaches before making a final decision.   The Nevada courts prefer the Periera method over the Van Camp method, if the facts make it too close a call to decide which formula to choose.