How to Value a Business in a Florida Divorce
How do you value a business for a divorce?
Valuation of a business is one of the most complex and contentious issues. There are many opportunities to manipulate the underlying numbers. There are three major methods of valuation: The Income Approach, the Market Approach, and the Cost Approach. Each method has advantages and disadvantages depending on your goal.
One potentially valuable “marital asset” that may be present in a Florida divorce is a business operated by one or both ex-spouses. One or both ex-spouses may have operated a business during the course of the marriage and derived most or all of their income from this business. Or the business may have been just a side-venture that did not produce much, if any, extra money. Regardless, properly classifying and valuing a business is essential in order for there to be a fair and equitable division of the marital property. But assigning a monetary value to a business is not as easy as it sounds; doing so accurately often requires the assistance of one or more experts. What follows is meant to be a general overview of how Florida courts place a monetary value on a business during a divorce.
Types of Businesses in a Florida Divorce
There are five main forms of business organizations. These include:
- Sole proprietorships, which are the simplest form of business organizations. The business is owned and operated by a single person and typically is a service-oriented business. The ex-spouse who prepared tax returns as a side business from her house was likely running a sole proprietorship. In a sole proprietorship, the earnings and losses of a sole proprietorship are included on the sole proprietor’s personal tax return.
- Partnerships, which are one of the most common forms of business organizations. A partnership can be formed either through an informal or unspoken agreement between two individuals or through a complex and well-articulated agreement. The defining characteristic of a partnership is the presence of two or more people who intend to carry on as co-owners of a business for profit.
- C corporations, which are a rare form of business to encounter in divorce cases. C corporations pay income tax on their taxable income. Shareholders often experience “double-taxation” in that the corporation pays income tax on its taxable income, and shareholders must pay taxes on any distributed dividends. The owners of some closely held organizations elect to pay themselves additional compensation, which reduces the taxable income of the corporation.
- S corporations, which avoid the problem of double-taxation present in C corporations. Instead, an S corporation’s earnings are taxed to the shareholders. All shareholders share in the profits, losses, and distributions of the S corporation according to their individual percentages of ownership.
- LLCs, which are a relatively new form of business entity that is created by a state’s statutes. LLCs typically protect their owners from being held personally liable for corporate actions and, similar to S corporations, owners are only taxed once on business earnings.
It is important to note that, in some cases, an ex-spouse may hold a majority or minority interest in a business, but not own the entire business him- or herself. For instance, the husband may own a 25% interest in a family business at the time of divorce. This 25% interest would need to be valued as well.
Separate or Marital Property?
Before valuation of any business in a Florida divorce can begin, the business must first be classified as either separate or marital property. In general, separate property is that property that one spouse owned or inherited prior to the marriage, whereas marital property is that property that one or both spouses acquired during the marriage. For example, suppose that Dan owns and operates a successful towing business. He then marries Donna. If Dan and Donna were to divorce, Dan’s tow truck business may be classified as separate property. Conversely, if Dan and Donna marry and then Dan starts his towing business, the business is likely to be classified as marital property.
Separate property can become marital property in certain circumstances. If the proceeds or income from a business is used to support the marriage or commingled with other marital property (i.e., deposited into a joint bank account), a business that might otherwise be classified as separate property may be deemed to be marital property. In addition, an increase in the value of a business – especially if both spouses contributed to the increase – may be classified as marital property. Assume again that Dan started his own towing business before he met and married Donna. On their wedding day, Dan’s towing business had a value of $100,000. During the marriage, Donna helped out at the towing business as a secretary and bookkeeper. At the time of their divorce, Dan’s towing business was determined to be worth $250,000. Even if Dan’s business is found to be separate property, a court may find that $150,000 of it is marital property since the increase in value occurred during the marriage, presumably from the efforts of Dan and Donna.
Valuation of the Business in a Florida Divorce
Once the business has been described and classified as either separate or marital property, it is time to value the business. A valuation expert – sometimes a certified public accountant or other individual with expertise in this area – is often used to perform this task. As part of the valuation process, the appraiser will typically review the business’s financial records, accounts payable and receivable, and visit any real estate that the business owns, such as a garage or manufacturing center.
In addition, and depending on the type and size of business involved, an appraiser’s job will also involve assigning a value to “intangible” aspects of the business, such as the business’s reputation and professional “good will.”
The process begins with an appraiser determining the “standard of value” that will be used; that is, will the appraiser determine what the “fair market value” of the business is or will some other standard (such as “investment value”) be used? These two values are not always the same. A fair market value represents the amount of money that would change hands between a buyer and a seller under reasonable circumstances. On the other hand, investment value represents the amount a particular buyer or investor with specialized knowledge or motivation would offer. For instance, there may be a difference in the value of Dan’s towing business to a normal, average seller and someone who plans to invest in and modernize the business in order to increase the revenue and efficiency of Dan’s towing business.
There are three general approaches that appraisers use in determining the value of a business:
- Income Approach: This is probably the most widely used approach in business valuation. The value of the business is based on the company’s present earnings, or the future earnings that the business is expected to produce. If the value of a business is based on the future earnings or future value of the business, then the appraiser will use formulas and assumptions to arrive at a present value of the business.
- Market Approach: The market approach is a way of determining the value of a business through a process of comparison. In essence, the appraiser finds “guideline companies” that provide a reasonable basis for comparison for the business involved in the divorce. The business interests involved in the divorce are compared to similar interests from similar companies that have recently been sold. If an appraiser uses this method, it is important that the appraiser compares the business at issue in the divorce to a comparable business. Otherwise, the value derived for the business at issue in the divorce may be either too high or too low.
- Cost Approach: The cost approach is sometimes referred to as the “asset-based approach.” The theory underlying this approach is that a potential buyer of a business would not pay more than the amount necessary to buy the business’s assets, taking into account any liabilities of the business.
Sometimes there is a dispute between the ex-spouses as to the true value of a business. Because Florida is an equitable distribution state, courts will try to split the marital assets in a fair and equitable manner between the parties. If a business is valued higher than it otherwise should be, this can result in the non-business-owner ex-spouse receiving a larger share of the marital estate. On the other hand, if a business is valued lower, the non-business-owner ex-spouse might not receive as much of the marital estate as she might otherwise receive.
Although a good and reputable appraiser is a neutral party to the divorce – that is, he or she is not to favor one side or another – it is important to know what method an appraiser uses when valuing a business. Each party to a divorce can usually present evidence as to the value of the business, and thus can usually present appraisals from different appraisers. Obtaining an accurate appraisal of a business and its assets is essential in arriving at a fair and equitable division of the property.
For instance, suppose Dan and Donna are divorcing and Dan’s towing business is identified as a marital asset. Dan’s towing business is just starting to take off and is poised to make quite a bit of income in the future. However, at the moment, the assets of the business consist only of an older model tow truck and a small, rented office with a phone line. Donna hires an appraiser, who uses an income approach to valuing the business. In looking at the future expected earnings of Dan’s business, Donna’s appraiser may value the business at $250,000. Assume that the marital estate consists of $1,000,000 in assets. If the court decides to award Dan his $250,000 business, that means that Dan will only receive another $250,000 in assets while Donna will receive $500,000.00 in assets (assuming the court divides things equally).
Now assume that all facts in the above hypothetical remain the same, except that Dan’s appraiser uses a cost approach to valuation and finds the assets of the business (and hence its value) is $100,000. The court awards the business to Dan. In this case, Dan would receive another $400,000 in assets.
While an appraiser is typically an expert in valuation, the value of a business is still a matter for the court to decide. When presented with different valuations, the court will have to resolve the differences. A court may do this in a variety of ways. For instance, the court may adopt one appraisal or the other, discounting the other appraisal entirely. The court may “split the difference” between the two appraisals. Or the court may direct that an appraiser chosen by the court be ordered to conduct an appraisal, perhaps using a particular method or approach.
How Will a Court Divide a Business in a Divorce?
Once the business has been properly valued, the court’s final task is to award the business to one or both parties. The court may award the business in its entirety to one spouse or the other and then “offset” this award by giving the other spouse additional assets. Or the court may award a portion of the business to one spouse and the remainder to the other. But if the parties can agree as to how the marital assets (including the business) are to be divided, a court will usually honor such an agreement so long as it does not appear one spouse is taking advantage of another.
In dividing the marital property, the value of the business may also play a role in determining whether the non-business-owner ex-spouse receives any alimony and, if so, how much alimony should be awarded.
Conclusion on Valuing Businesses in a Florida Divorce
Valuing a business in a Florida divorce is not as simple a task as it might first appear. Valuation involves much more than finding out how much is on deposit in the business’s accounts or seeing what sort of real estate the business owns. Instead, it almost always requires the use of an expert trained in the processes and methods of business valuation. But it is worth one’s while to ensure that a business is properly valued, as an accurate valuation will assist the court in making a fair and equitable division of the marital property.
Experienced Attorneys in Handling Business Issues
We can provide competent trained attorneys in cases involving business assets. At Ayo and Iken we offer an aggressive legal team that is ready to fight for your rights.