Valuing a Buiness During a Divorce

Posted: 10 July, 2020

Valuing a Business In a Divorce

Valuing a community property business during a divorce proceeding is one of the most difficult and often most contentious issues. The goal of valuing the business is to obtain an equitable division of the value of the business.

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. The asset based approach is where the tangible assets of a business are given a fair market value.
  2. Income Based approach. The income based approach seeks to determine the value of a business by assessing the present value to future earnings.
  3. Market Based approach. The market based approach is determined by comparing it to other similar businesses.

Choosing which approach is the first step in valuing a business.

Asset Approach

The asset approach adds up all the assets and liabilities of the business. The liabilities are subtracted from the assets and what is left over is divided between the parties. Unfortunately, this is not as easy as it sounds. Assets and liabilities refer to tangible and intangible property.

This method may work well for businesses that have value based on tangible assets, such as real estate, equipment, inventory and accounts receivable. An intangible asset refers to things like intellectual property, contracts for doing business and goodwill. For professional practices that have few tangible assets and gain their value more from goodwill than from the assets it owns, the asset approach is usually not the best one.

Income Approach

This is based on different mathematical approaches based on cash flow, all of which basically convert expected future profits into a present day value. The evaluator reviews the history of the specific business and compares its profits to other similar businesses. Risks of failure are also considered.

Market Approach

This is a similar method to the one used by real estate agents when they determine the price to put on any property for sale. The sale price of other similar businesses that have been recently sold are compared. The fair market value of the community property business is determined to be within the price range for what those businesses actually sold. The problem is in finding businesses that have sold that are truly comparable. This may even be impossible. The price the business sold for may have been influenced by unknown factors, such as the motivation for the sale. The business sold may have been discounted for some unrevealed reason so the sale is not truly comparable. Other comparisons may not be accurate when the size of the business, number of employees, annual profits and other variables are considered.

Apportionment methods

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. 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.

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.

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.

Contact an Experienced Nevada Divorce Lawyer for Assistance with Business Valuation

The valuation process is complicated and may require a combination of methods. The services of a Las Vegas divorce attorney and a business valuation expert can ease the process and determine the most fair and accurate value of the business for an equitable distribution.