When it comes to divorce, one of the most challenging aspects can be determining the value of a business. For business owners, this process can be especially complicated. Whether it’s a family-owned business, a startup, or shares in a large corporation, the way it is valued will have a significant impact on how assets are divided in a divorce. Business valuation can be complex, and it requires careful consideration and often, expert opinions.
Over the years, prenups have become an increasingly popular tool for protecting business assets before marriage. By setting clear expectations ahead of time, prenups help protect what is often a business owner’s most valuable asset: the business. For entrepreneurs, this kind of foresight can provide peace of mind, knowing that if things don’t work out, their business won’t be entangled in a complex, litigated, and, well, expensive divorce process.
What is business valuation?
Business valuation is the process of determining how much a business is worth. In a divorce case, this valuation is essential so that the owner’s stake in it can be fairly divided between spouses. The process includes looking at the business’s assets (like equipment, property, and intellectual property), liabilities (any debts or financial obligations), earnings, cash flow, and goodwill, and the intangible value, like customer loyalty or brand reputation, to quantify total business value.
Business valuation is a complex process, but with good professional guidance, it can be managed effectively. We spoke with an expert witness in divorce trials on business valuation, and here’s what he said:
“Valuing a business in the context of divorce can be one of the most complex aspects of the process. For business owners, the stakes are particularly high. Whether it’s a family-owned business or a startup, ensuring a clear and professional business valuation through a prenup can provide a roadmap for how the business will be treated in the event of a divorce. Prenups allow business owners to protect their most valuable asset and save time, money, and emotional energy down the road.” – Bob Gorton, CPA, ABV, CFF
How courts approach business valuation in divorce
In family law cases, determining the “standard of value” starts with two key concepts:
- Value in Exchange refers to the potential price at which a business or business interest might be sold in a hypothetical transaction, assuming the business is exchanged for cash.
- Value to the Holder looks at the worth of a business or business interest from the perspective of its current owner without any intention to sell. It focuses on how the business benefits or serves the owner personally.
All’s fair… kind of? Fair market value vs. fair value
Valuing a business during a divorce is rarely a straightforward process, especially if the business is privately owned or family-run. Unlike publicly traded companies, which have stock prices that are readily available, privately held businesses don’t have a clear market price. This makes it harder to figure out their true worth.
Fair Market Value
In divorce cases, the most commonly used standard of value for valuing assets is Fair Market Value (“FMV”). FMV represents the price a willing buyer would pay to a willing seller in a hypothetical transaction, where both parties have a reasonable understanding of the asset and aren’t under any pressure to complete the sale. This standard is widely recognized by the IRS, business valuators, and courts.
The key aspect of FMV is that it assumes a hypothetical buyer, meaning it doesn’t take into account the specific preferences, opinions, or assumptions of either the buyer or the seller. Business valuators apply this perspective when making decisions or adjustments related to factors like control, marketability, liquidity, and goodwill.
Fair Value
Fair Value is the price at which an asset would be exchanged between a willing buyer and a willing seller, but it’s often used when there isn’t an active market for that asset or when one party is forced to sell. In divorce and business valuation, Fair Value is sometimes preferred over FMV because it is meant to ensure ‘fairness,’ particularly when one party holds a minority interest or isn’t in a position to easily sell the asset. Unlike FMV, which looks at what the asset could sell for in an open market, Fair Value excludes discounts for lack of marketability and lack of control. It’s often used in situations where the goal is not to rely solely on market conditions to set a price.
Investment Value
Investment Value in a divorce case refers to the worth of a business from the perspective of a specific buyer or investor, considering their unique circumstances, goals, and financial situation. Unlike FMV, which assumes a hypothetical buyer in a neutral setting, Investment Value takes into account how much the business is worth to an individual investor based on factors like potential synergies, personal preferences, or strategic goals. For example, one spouse might value the business higher because it complements their other investments or fits into their long-term plans.
In divorce cases, Investment Value can play a role when one party wants to retain the business or when a particular buyer is interested in purchasing the business based on their own objectives. This value is highly subjective and can differ significantly from the market-driven value because it reflects what the business is worth to a specific party rather than to the general public.
Goodwill
Another tricky aspect is the difference between personal goodwill and business goodwill. Personal goodwill is tied to the owner—their reputation, relationships, skills, and expertise. For example, a business owner’s personal connections or unique expertise may be what makes the business successful. Business goodwill, however, is tied to the company itself—its brand, customer loyalty, and overall operations. In a divorce, personal goodwill is often not considered part of the business’s value because it’s tied to the individual. Business goodwill, on the other hand, is part of the business and can be divided.
Distinguishing between these two types of goodwill can be difficult, and courts sometimes struggle to separate the personal value of the business owner from the actual value of the business. This can have a big impact on the valuation and how the business is split up in a divorce.
“Businesses with personal goodwill tend to be those in professional services, such as medical practices, law firms, CPA firms as well as creative services, like marketing and graphic design companies. These all rely primarily on the reputation and skills of their owners to ensure their success.” – Bob Gorton, CPA
Prenups: How to get a business valuation
If you are engaged and a business owner, it is important to have your business professionally valued for purposes of your prenup financial schedule, whether you own all or part of the business. The valuation should be included as part of the financial schedule in the prenup, which outlines each spouse’s assets, liabilities, and income. Adding the business valuation as backup documentation to the prenup provides clarity for both parties, helps with future enforcement, and eliminates the argument that either party would not have entered into the agreement had they only known the value.
To practically determine the value of your business, there are a few approaches you can take depending on your resources, the complexity of your business, and the purpose of the valuation:
Last Round of Funding
If your business has gone through a recent funding round, such as venture capital or other investments, the valuation from that round can be a good starting point. The price investors were willing to pay for a stake in the company reflects how much they believe the business is worth. This valuation may not account for recent changes in your business or market conditions, but it can provide a solid baseline if your business has received professional attention and investment. However, keep in mind that this is only one perspective—investors are looking for returns, and their valuation might not fully reflect the business’s true worth to you or in other contexts (like a divorce).
DIY, Why Not?
If you’re looking for a quick estimate or trying to get a rough idea of your business’s worth, you can try valuing it yourself by looking at key financial metrics. This is not foolproof and can lead to issues down the line if this value is ever in dispute. If you choose this DIY approach, you can use the asset-based approach by calculating the value of your business’s assets (e.g., real estate, inventory, intellectual property) minus its liabilities.
Alternatively, if your business generates steady income, you can use a multiple of earnings method (like EBITDA) or revenue-based multiples common in your industry. However, valuing a business yourself can be challenging, especially if you don’t have experience in financial analysis. It’s often difficult to assess subjective factors like goodwill, market position, or growth potential.
Here’s what financial experts have to say about DIY business valuation:
“While it might seem tempting to perform your own business valuation, it’s risky. Without proper financial analysis, you could overlook important factors like market position and future growth potential—elements that can significantly impact the true value of your business. Hiring a professional ensures you have an accurate, credible valuation that takes all relevant factors into account.” – Bob Gorton, CPA and expert witness on business valuations in divorce trials.
Hiring a Professional Business Appraiser
For an accurate, objective, and legally defensible valuation, especially in high-stakes situations like divorce, hiring a professional business appraiser is often the best choice. A certified business appraiser will use established methods to assess your business’s worth, such as the income approach (Discounted Cash Flow), market approach (comparable sales), or asset-based approach. Appraisers are skilled at considering all relevant factors, including business risk, market conditions, and intangible assets like brand value or customer loyalty. While hiring an appraiser comes with a cost, the result is a thorough and reliable valuation that can be used in legal documents such as your prenup.
What is required for a business valuation
If you decide to go the professional route for a business valuation, there are several key documents typically required to ensure the appraiser or financial professional has a complete and accurate picture of the business’s financial health and performance. The specific documents needed can vary depending on the type of business and the approach being used for the valuation, but there are a few common ones that are usually required.
Financial Statements
The most critical documents for any business valuation are the company’s financial statements. This includes the balance sheet, income statement (profit and loss statement), and cash flow statement for at least the past 3-5 years. These documents provide a snapshot of the business’s assets, liabilities, income and expenses, and cash flows, which form the basis for most valuation methods. Financial statements offer insights into the company’s overall profitability, liquidity, and solvency, helping the appraiser determine the business’s financial stability and growth potential.
Tax Returns
Business tax returns are also essential, as they give an external verification of the financial information presented in the internal financial statements. Most appraisers will request copies of the business’s tax returns for the past 3-5 years. These documents help ensure that the reported income and deductions are accurate and consistent with what has been filed with the IRS. Tax returns are particularly useful for verifying revenue, expenses, and net income, as well as assessing the business’s historical tax burden.
Ownership and Legal Documents
For a valuation, the appraiser will also need to understand the ownership structure of the business. This includes the business structure, ownership agreements, corporate bylaws, shareholder agreements, and any others that are applicable. These documents help clarify how ownership is divided among the business’s stakeholders and may provide insight into how control or decision-making is structured within the business. Additionally, if the business has intellectual property rights or patents, the appraiser may need documentation on these assets to assess their value as part of the overall business valuation.
Contracts and Agreements
Any key contracts or agreements that the business is a party to, such as customer contracts, supplier contracts, employment agreements, or leases, should also be provided. These documents give the appraiser insight into the business’s ongoing commitments, revenue streams, and liabilities. Long-term contracts, particularly with key clients or vendors, can be a valuable asset, while unfavorable contracts or upcoming renewals can negatively impact the valuation. For businesses with significant goodwill, such as those based on customer relationships, these contracts are crucial for understanding the stability and sustainability of future cash flows.
Business Plans and Projections
If available, providing business plans, financial projections, and forecasts can be helpful in the valuation process. These documents give the appraiser an understanding of the company’s future prospects and growth potential. Projections may include expected revenue growth, changes in operating expenses, and future capital expenditures. If the business is a startup or in a high-growth phase, these projections help to give context to the historical financial data and can be factored into a more forward-looking valuation method, such as the discounted cash flow approach.
“Detailed, well-thought-out projections provide the valuer with a comparison of the proposed future of the business with its past results.This allows the valuer to base business value on the future, which is how it should be valued.” – Bob Gorton, CPA
Industry and Market Information
Finally, providing industry reports, market analysis, and competitive data can support the valuation by giving the appraiser a better understanding of the external environment in which the business operates. This information can be particularly useful for determining market multiples or assessing the business’s relative position in its industry. Market trends, competitor performance, and overall industry health can have a significant impact on the business’s value, particularly for businesses that are highly influenced by market conditions.
Conclusion
Valuing a business during a divorce can be complicated, especially when that business is a major part of the marital estate. Whether it’s a family business, a startup, or shares in a larger company, understanding the business’s true value is essential for a fair division of assets. This is where prenuptial agreements can really help. By planning ahead and including a business valuation in the prenup, business owners can protect their assets and avoid the expensive, stressful, and often confusing process of negotiating business value during divorce. Prenups create clarity from the start, helping both parties understand how the business will be handled if the relationship ends.
Written with contribution by: Bob Gorton, CPA, ABV, CFF
Bob Gorton is a highly regarded Certified Public Accountant with specialized credentials in business valuations and forensic accounting. Holding the Accredited in Business Valuation (ABV) and Certified in Financial Forensics (CFF) designations, Bob has established himself as a leading expert witness in divorce trials. With extensive experience in financial analysis and business valuation, he assists attorneys and courts in evaluating complex financial matters, particularly in divorce cases involving business interests, asset divisions, and income determinations.
Julia Rodgers is HelloPrenup’s CEO and Co-Founder. She is a Massachusetts family law attorney and true believer in the value of prenuptial agreements. HelloPrenup was created with the goal of automating the prenup process, making it more collaborative, time efficient and cost effective. Julia believes that a healthy marriage is one in which couples can openly communicate about finances and life goals. You can read more about us here Questions? Reach out to Julia directly at Hello@Helloprenup.com.
0 Comments