Valuing a Buiness During a Divorce
Valuing a Business During a Divorce
During a divorce, a division of assets and possibly spousal support will need to be agreed upon by both parties or ruled on by a judge. A business owned by the couple, especially one of a professional nature, has both a business value component and an income aspect. Properly valuing the business and dissecting the income earned from the business from the value of the business can be a tricky situation. The simple solution is to sell the business, pay off debts and then the couple will equally divide the business. This is the minority solution because most businesses provide the income to the couple. In the event the business is not sold, the court will typically assign the operating spouse the ownership of the business and a value to buy-out the remaining spouse will be calculated.
There are three main approaches for determining the value of a business: 1) Asset Based approach, 2) Income Based approach, and 3) Market Based approach. The income based approach seeks to determine the value of a business by assessing the present value to future earnings. The market based approach is determined by comparing it to other similar businesses. The asset based approach is where the tangible assets of a business are given a fair market value.
The Asset Based Approach
For example, a mechanic owns an auto repair shop for ten years. They get married in year five and divorced in year ten. The asset-based approach is going to look at all of the assets that the shop accumulated during the marriage. This includes all of the tangible assets such as equipment, land, property, cash, etc. If the all of the property was acquired after the marriage then the division will most likely be a 50/50 split.
Goodwill is one of the most interesting parts of business evaluation. Goodwill is explained as the name or brand or reputation that a business may have in a community. If your business has lots of goodwill then customers are likely to return for your services or would pay a premium for the business services. Goodwill is an intangible asset that may be used in Asset Based Approach or Market Based Approach.
The Market Based Approach
An easy way to think of the Market Based approach to valuing a business is to find out how much someone else would pay for the business today. Whatever that price is it includes the current value of assets, liabilities and future earnings that the business may make. This is one of those situations where intangible assets can be valuable. Because we are talking about future earnings, positive goodwill does increase the value of a business. A capitalization rate, which provides investors a way tof comparing this investment versus other investments, is often used in a Market Based approach.
The Income Based Approach
Most of us understand the principle behind an Income Based approach, but it is the most subjective approach of the three. Income Based approaches can be subjective to how income is recorded. Some business appraisers use gross revenues as the value basis, others rely on EBIT and other appraiser prefer net profits. Add in the complexities of a professional business where a salary needs to be extracted before the valuation and you can see where the two Income Based valuations can be completely different.
Choosing which approach is the first step in valuing a business. Service businesses or professionals such as doctors or lawyers are typically valued using the Income Based approach. A business with lots of market based comparable such as a hair salon or pizza restaurant can use the Market Based approach. A business with equipment like a garage or manufacturing business may use the Asset Based approach.
Business appraisals must be conducted by a professional appraiser, CPA or forensic accountant. The parties can choose to agree on one appraiser, but usually each side will submit a value from their appraiser and the judge will make the final ruling.
It is important that whomever you choose to value the business that they are experience with all three approaches and are familiar with looking for hidden assets and forensic accounting.