Understanding Business Valuation in Divorce for Privately Held Businesses

Valuing a privately held business during divorce proceedings in California can be complex, particularly when the business has both separate and community property parts. Privately held businesses are simply businesses whose shares are not publicly traded. They can come in all manner of sizes from a single employee to tens of thousands. There are several factors that can impact valuation along with different methods to determine a business’s value. Here’s an in-depth look at the intricacies involved:

Methods of Business Valuation

Determining the correct method of valuation can depend on the type of business, its operations, earnings and assets, and more. There are various types of business valuation methods: including asset-based, income-based, market-based approaches, and capitalization of excess earnings.

• An asset-based approach assesses the company’s assets and subtracts liabilities to determine net worth. It’s useful for businesses with substantial tangible assets. However, it may not accurately reflect a service company’s or any business relying on goodwill.

• An income-based approach estimates the future earning potential of the business, translating it into present value based on cash flow or earnings projections. It’s particularly relevant for businesses with strong growth potential or consistent revenue streams.

• A market-based approach compares the business to similar companies that have recently sold. However, finding adequate comparable aspects can be challenging for unique businesses.

• Capitalization of excess earnings subtracts from the owner’s earnings, reasonable compensation, and the result multiplied by a capitalization rate which is often a discretionary call by the valuation team.

Often a valuation will weigh various approaches to arrive at a conclusion. It is important to note there are also rules of thumb valuations that are generally accepted in specific industries.

Separate vs. Community Property Interests in a Business

A common factor that complicates valuation for divorce purposes includes identifying Separate vs. Community Property interests in a business.

Businesses owned before marriage or acquired by gift or inheritance during the marriage may be classified as separate property. Thus, their value at the time of marriage or acquisition would typically remain the property of the original owner.

Any business interests that were acquired or those that grew in value during the marriage are usually considered community property. In California, community property is generally divided equally between spouses upon divorce.

When businesses have both separate and community property components, determining what part of the business value is separate and what is community can become complicated, requiring a careful review of business financial records, ownership documents, and the timeline of ownership and contributions.

Valuing Intangible Aspects of Business and Other Complications

In addition to determining separate and/or community property interests, there are other factors that can further complicate a valuation.

For instance, if the non-owning spouse contributed to the business (e.g., through helping with operations, marketing, or management without formal financial compensation). It may be necessary to assess how those contributions affected the business’s value.

Valuing the intangible aspects of the business – such as reputation, customer relationships, and brand value – can be difficult and subjective. Goodwill needs to be properly identified and valued, particularly since it could be considered community property if the business developed during the marriage. There may also be arguments about the appropriate date of the valuation where there is a material change in the value after the spouses separate. Further, economic fluctuations, industry trends, and specific circumstances surrounding the business can significantly affect its value as well but are often difficult to predict or measure.

Due to the complexities involved in valuing a business, engaging financial experts, such as forensic accountants, in addition to your attorney is often essential.

Experienced Business Valuation Divorce Attorney

The valuation of a privately held business in the context of a divorce in California is challenging due to the interplay between separate and community property parts, various valuation methods, and the necessity of understanding both financial and legal implications.

Given these complexities, relying on professionals, including legal and financial experts, is critical for achieving a fair and accurate valuation. This thorough approach can facilitate an equitable division of assets and help prevent disputes during what is often a highly contentious process. With over forty years of family law experience, including business and asset valuation, property division, high-asset divorces, and complex compensation, I have the experience and expertise to guide you through the valuation process in a divorce. If you are facing a divorce and own a business, Contact Me or call our team at (888) 851-1611 to review your rights and options.