Business Valuation in a Divorce: What Is Your Business Worth?
About 90% of U.S. businesses are family owned so it’s no surprise that one of the first questions divorcing couples ask themselves is, “What is the business worth?” Obviously, both parties to want as much as they can get which often leads one party to undervalue the business and one party to overvalue the business. So you can easily see why agreeing on the value of a business can be one of the most contentious and expensive issues in a divorce.
In order to have a realistic understanding of what a business is worth, you need to hire a business valuator. Just as a bank insists on an appraisal of real-estate specific to your address, before issuing a mortgage or a dealer appraises a diamond ring, an expert business valuator ensures that a fair value of a business is determined based on knowledge of the relevant facts. Calculating the value of a business isn’t an exact science. A typical business valuation in the Hartford Area can cost between $5,000 and $30,000. In the Westport, New Haven or Greenwich area, the cost for such a report can start at $10,000. Factors that affect a business valuation include the size of the business, the quality of the financial records, whether or not a purchaser winds up with a controlling interest, and the vicissitudes of the market.
Even if they can’t get along, the couple needs to interview and hire the business valuator together. While each party may be tempted to get their own business valuator, doing so can get expensive. They run the risk of winding up in a court with dueling experts – experts who are getting paid by the hour. A mutual decision about who will valuate the business ensures that at the end of the process both spouses can accept the valuation report.
Methods of Business Valuation in a Divorce
The first decision that a Business Valuator will make when assigning value to a business is to decide which standard of value to apply to the business– Fair Market Value or Investment Value are some of the standards of valuation. Very simply put, Fair Market Value is the amount at which a business interest would change hands between a willing seller and a willing buyer when neither is acting under compulsion and when both have reasonable knowledge of the relevant facts. Investment value is the value of the business to a specific investor. It is possible for a business’s fair market and investment value to be the same. However, it is more likely the investment value is higher or lower than market value depending on who is doing the bidding. While fair market value of a business tends to remain steady over time, investment value cane be more unpredictable.
3 Ways Your Business Can Be Evaluated in a Divorce
There are three approaches that a business appraiser may use to valuate a business in a Connecticut divorce.
The Income Approach to Business Valuation
The income approach is probably the most widely used approach in business valuation. Under the income approach, the value of the business is based on the company’s earnings or the future earnings the business is expected to produce. The company’s earnings stream or future benefits are then converted to a present value and a final number is arrived at. Using an income approach, there is a direct relationship between the amount of earnings or benefits the company will generate and its value.
The Market Approach to Business Evaluation
Using a market approach, the business is valued based upon reference to other transactions — in real estate referred to as comparable sales. In the market approach, there are 3 options.
- Publicly Traded Guideline Company MethodIn this method of business valuation, the valuator finds comparable publicly traded companies. The valuator examines the multiples* from the stock prices and financial data of the guideline companies and applies these multiples to the financial data of the business being appraised. Of course this method is commonly applied to larger companies and opposed to small family businesses.*A multiple measures an aspect of a company’s financial well-being and is determined by dividing one metric by another metric. A commonly used multiple is price-to-earnings (P/E) ratio. Learn more about multiples here: http://www.investopedia.com/terms/m/multiple.asp
- Comparative Transaction Method (Mergers and Acquisition Method)In this valuation method the appraiser finds companies that were sold in the past which are comparable to the business in question. The companies may be in the same industry, be about the same size, serve the same markets and have a similar assets. This business valuation method is ideal for companies that are fairly common like restaurants, retail shops or construction companies.
- Past Transactions MethodThis method of valuation is often significant in divorce valuations because it uses any past transactions of the company’s own stock. Similarly, “buy-sell agreements” are often considered by the divorce courts in fixing the value of business — especially when they are negotiated when a divorce is not contemplated.
The Asset Based Approach to Business Valuation
Using an asset based approach; a business is valued on the basis of its assets and liabilities. Under this method of valuation, the company’s assets and liabilities are adjusted to their current fair market value. This method is primarily used on the basis of a going concern value and is frequently used for underperforming companies. This approach is not appropriate for companies with high intangible value.
The Institute of Business Appraisers (IBA) and the American Society of Appraisers (ASA) have issued standards for valuing businesses; therefore, valuators can apply similar procedures. The appraiser should also be familiar with state divorce law in CT.
If you are contemplating a divorce, the most important factor to consider when choosing a business valuator is practical and professional experience. Experienced business valuators have understanding of the market, what unique businesses are selling for, experience in reading and interpreting complex financial records and how to locate assets and expenses which may need to be included in the business valuation. When interviewing the business valuators, ask for specific examples of businesses they have valuated in your industry.
If you are contemplating divorce and you need to ascertain the value of your business, contact CT Mediation Center. Our attorneys have worked with business owners and have built professional relationships with business valuators. We can guide you through the process and can help you interview and select the right business valuator for your unique situation.