What METHODS are used for VALUING BUSINESSES in divorce?

Q. I own a business that I began shortly after marriage. Now I am getting divorced. Is this community property even though my partner never worked the business, and if it is what methods might be used to value it?

A. With certain exceptions where, for instance, there has been a transmutation of a community property interest in a business to your separate property per Family Code section 852 (which requires a writing signed by the party adversely affect showing an intent change the character of property from community to separate), all property acquired during marriage through the time, skill and efforts of either spouse is community property. Family Code section 760.

A business begun by one spouse after the date of marriage and before physical separation will need to be divided in a dissolution or legal separation proceeding, and if you and your spouse cannot agree on its value it may need to be evaluated by an expert. This is usually accomplished under the provisions of Evidence Code section 730.

There are a number of methods that can be used to value a business, and depending upon whether the business sells services or products different valuation methods may be more appropriate than others. As a general overview, these include:

  • Evaluating sales proceeds

When a business is actually being sold in an arm's length transaction to a third party, the price that a willing buyer will pay and a willing seller accept determines value. This is rare in the case of business valuations, but more common with respect to real property.

  • Comparables

The specific asset is valued based upon the actual sales of similar assets or properties with actual sales that can be tracked. With professional practices, this is common with dental businesses which are commonly bought and sold, and so numbers from the sales of other dental practices may be persuasive to a court. Whether this method is useful depends very much on the nature of the business - sometimes there is nothing comparable or little published information about comparable sales. Comparables are also considering in setting the value of real estate.

  • Liquidation value

Sometimes businesses will be cut up into parts that are sold separately. Sometimes the business is valued in terms of what these parts would sell for. It is rarely used except when the parties intend to actually liquidate the company. Liquidation value does not generally include valuing goodwill (because the assumption is there will be no on-going concern). Goodwill is the nightmare component to valuing businesses. Many people in divorce who manage the business believe strongly this is how businesses should be valued (in part because in the absence of an actual sale, it is a fiction to say what a buyer might pay when no such buyers as a practical matter exist).

  • Book Value

This relies upon the company records to determine what 'retained value' is. It is rarely used, because it is more a statement of how the company perceives itself, or structured (or even 'cooked') its books, than any objective indication of value.

  • Adjusted book value

This is performed through a forensic audit. Usually it is performed on a cash basis, and accounts receivable and much more must be analyzed.

  • Going concern value

This describes a method that includes valuing the business as greater than the sum of its parts. There are a number of factors that are used.

  • Capitalized earnings

This is the most common method for valuing businesses used in California because courts find it to be most reliable. If you hope to use a different method, you will need to justify why that method is fairer to the out-spouse. This method requires expensive forensics.

It is not uncommon to bifurcate the question of business valuations to try them separately because often this is the thorniest issue to be decided in a dissolution or legal separation proceeding.

The law of business valuations is extremely complex and even contradictory. The purpose of this blog is merely to introduce the concepts. I will develop these themes in more detail in additional family law blogs.

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T.W. Arnold