Divorce is challenging enough in itself, yet getting to a final settlement can be further complicated if one or both spouses have an ownership interest in a closely held, private or small business. In these cases, the business may be a significant source of income for the family, as well as a potential asset subject to division.
The first step is to determine whether the business interest is considered a marital asset or separate property. Was the business owned prior to marriage? Were community funds used to acquire the business? Were communityfunds and/or personal efforts contributed to the business by either or both spouses during the marriage?
Next, the business interest needs to be valued. Valuing or appraising a business is a complex task, and may require the assistance of a professional business appraiser. If the business is very small, it may not merit the expense and complications of a forensic accountant. It may be possible to value tangible assets, receivables and bank accounts in order to include a nominal value for the business. Or, alternately, your divorce financial planner may perform a rudimentary valuation based on income tax returns and historical income.
Measuring “goodwill” is another component of assigning a value to a private business. Goodwill is an “intangible asset arising as a result of a name, reputation, customer loyalty, location, products and similar factors not separately identified.” Generally, goodwill is separated into three categories – entity or practice goodwill, professional or personal goodwill, and goodwill that is transferable.
“Practice goodwill” is the value associated with the professional practice and is based on location, policies and procedures, staff retention, established patient/client base and patient or client records. This type of business assumes that clients or patients are likely to stay with the practice despite a change in ownership.
“Personal professional goodwill” is used to describe the professional practice that has a higher value because of the specific professional’s knowledge, experience, skills and reputation. This would assume that if the practitioner were to leave to go to another practice, her or his clients would likely follow.
“Transferable goodwill” is personal as it relates to the individual, but over a certain period of time, that kind of goodwill can be transferred to another person or persons. This would include personal relationships, or specialized knowledge that the individual could transfer through training or development. And it may also include transferring contact lists, client/patient relationships, etc. along with a non-compete agreement.
Generally, most states, including Texas, do not consider “professional goodwill” a marital asset subject to division in a divorce.
If the business is determined to be a marital asset, and you and your spouse have agreed on its valuation, there are basically three methods of dividing its value in a divorce.
- Remain Co-Owners
- Buy out the Other Spouse, or
- Sell the Business
Remaining co-owners of the business is a rare choice, but possible if the spouses are amicable, trusting and respectful. Perhaps one would continue to primarily manage the business and the other would receive a percentage of the proceeds to satisfy his or her share of the marital assets. Each spouse would be taking a risk of receiving more or less assets under this arrangement. If this option is chosen, it is important that the spouses have a detailed operating or shareholder’s contractual agreement to address their new business arrangement as if they were independent investors in it.
Buying out the other spouse is the most popular method of dealing with a private business in a divorce. This only works if there is sufficient cash or other liquid assets (such as stocks and bonds) for one spouse to “buy-out” the other. It may be possible for the purchasing spouse to obtain financing in order to acquire the other spouse’s interest, or offset the business value by relinquishing to the other spouse full ownership in the marital home or other assets, i.e. 401(k), IRAs, pension funds, etc. of equal value. Or, the couple could agree to a structured settlement, where the purchasing spouse would use a property settlement note to make a series of payments over time to the other spouse, instead of a lump-sum payment.
Selling the business and dividing the proceeds is another solution if a buy-out of a private business is not a viable option for both spouses. This may require a court order if one spouse insists on continuing the business. If both spouses agree to a sale, they may disagree on its value or sale price, and face a number of other challenges depending on its marketability, profitability and current economic conditions. Selling a private business can take many months or years. The couple could be forced to continue to operate it until a buyer is found.
Valuation of the Closely held business
As mentioned earlier, valuing (“appraising”) a business is a very complex task, requiring the assistance of a professional business appraiser. If the divorce is cooperative, the couple can use one neutral appraiser who is far more likely to produce a fair, independent valuation. In a high-conflict divorce, spouses may want to obtain separate appraisals and meet in the middle. Yet, this can be problematic and costly if separate appraisers slant the results to favor their clients and end up causing the spouses to go to court to get a final determination.
Most skilled business appraisers offer more than one level of appraisal service, ranging from roughly $3,000 to $35,000 or more. To save money when employing an appraiser, organize your documents and provide a full set to your own lawyer and business appraiser, as well as to the spouse’s.
Start the search by looking for appraisers who hold either the Certified Business Appraiser (CBA) or Accredited Senior Appraiser (ASA) credentials. Earning either of these credentials requires the applicant to pass a highly technical exam and submit appraisal reports proving that they can perform appraisals competently. Look for a CBA or ASA appraiser at these organizations:
- Institute of Business Appraisers (IBA), http://go-iba.org
- American Society of Appraisers (ASA), http://www.appraisers.org/
A financial planner (CFP) trained in divorce financial issues, or a Certified Divorce Financial Analyst (CDFA), such as myself, can illustrate several outcomes of a proposed settlement using tables and graphs, assisting both spouses to see the long-range implications of their choices.