Even when there are no heated emotions, finalizing a divorce is often complicated. It can be complicated for legal reasons, financial reasons, or both. One factor that can make it harder to settle a divorce in Virginia is business ownership. This is because businesses here are regarded as property, and are therefore subject to division upon divorce.
For most couples going through a mediated divorce settlement, this means the value of a business (owned by one or both parties) must be calculated so each person has the information needed to determine who keeps various assets and liabilities following the divorce.
Below, we’ll answer some of the questions our clients often have about this issue.
Q:Why does my business have to be valued in connection with our divorce settlement?
In Virginia, your business can be considered marital property for the purposes of a divorce settlement. In other words, it is no different from your retirement funds, the house you shared as a married couple, your cars, furniture etc. All of it (assets and debts) must be assessed in the interest of fairness and full disclosure. This way both of you have all of the information you need to negotiate this aspect of your divorce settlement.
Q:What is marital property?
Marital property in a Virginia divorce is defined as all assets and debts acquired during your marriage with certain exceptions (namely exclusive individual gifts or inheritances). Anything classified as marital property can be divided and distributed in a Virginia divorce. This includes any business created during your marriage, or any part of a business created before you got married that enjoyed a significant increase in value while you were married due to your individual or collective efforts
Q: Is formal valuation of a family-owned business mandatory?
No. As long as you agree to do so in your divorce mediation, you can treat the business as only a source of income rather than also an asset. By treating it as a “job,” the business can be omitted from the settlement negotiations. Because this means that you won’t be privy to certain information, most lawyers and mediators don’t recommend this approach. But because it isn’t prohibited, you are free to implement this strategy if you choose.
Q: What would prompt a divorcing couple not to value a family business?
Depending on the type of business, it may be difficult to get an accurate assessment of its worth. This is especially true in “creative” businesses, or others with relatively few tangible assets (such as commercial real estate, machinery, vehicles and so on). This may sometimes lead to some “creative” approaches to the valuation process, which some couples find unacceptable.
Q: Does this mean that I’ll have to sell my business or allow my ex-spouse to participate in its day-to-day operations?
No. The spouse that owns a business is seldom forced to sell as part of a mediated divorce settlement, or split the daily operations of the business with a spouse who otherwise has little to no involvement. Instead, the value of the business is subject to negotiations along with the rest of the couple’s marital assets and debts.
How the negotiations play out depends on each couple’s situation. If a family-owned business is worth a lot of money, the couple may agree that the person who owns it should compensate the other spouse with a single payment or multiple payments over a specified period. Another option would be for the person who owns the business to retain 100 percent of the value in return for letting his or her spouse to have a greater share of other assets.
Q:How is a business valued for the purpose of divorce settlement?
In the context of divorce, Virginia courts have traditionally relied on the concept of “intrinsic value” to determine the worth of a business.
Three widely recognized methods for valuation are general used to determine intrinsic value. Each one carries different weight depending on the business being assessed and the person conducting the assessment.
- The income/excess earnings approach– This method is comparison-based. The person conducting the valuation compares how much the spouse that earns the business makes to the average income of someone in his or her peer group. If the spouse who owns the business makes more, any so-called “excess earnings” are assigned to the value of the actual business.
- The asset valuation approach– In this method, valuation of the business is based on its assets. As a result it is largely ineffective in the valuation of businesses with few tangible assets
- The market value (aka fair market value) approach– In this approach, the person doing the valuation bases intrinsic value of the business on the sale prices of similar businesses. Factors that are also considered in this approach include but are not limited to business marketability, the owner’s future earnings, the owner’s retirement plans and so on.
These assessments must be done by a business valuation expert, such as a certified valuation analyst (CVA) or a certified public accountant (CPA) with expertise in this area.
Q: What is “goodwill” and why is it so important in business valuation?
If a business had a good reputation, it has goodwill. Accordingly, goodwill is generally classified as an intangible business asset that increases its values. Companies with good reputations or goodwill use it to attract more clients and customers, thereby generating more revenue. In the context of divorce, Virginia law classifies goodwill as “personal” or “professional.” One of the key differences here is that personal goodwill is not divisible in a Virginia divorce, and professional goodwill is divisible.
Q: Is expert valuation of our business mandatory?
No. Some financially savvy couples choose to do their own valuation of family-owned businesses. As long as they can agree on which business valuation formula to use, they can simply gather the required financial information and proceed accordingly. While this can save these couples time and money, divorce lawyers and mediators will generally advise against a “do it yourself” approach to business valuation.
Q: How do you handle business valuation as a mediator?
One of the advantages of mediation is that it allows you to make certain choices. For example, you can each decide whether you want to have a formal valuation of the family business done (or whether you want to do it yourselves). To make this decision, it is important that you understand the concept of valuation, the concept of marital property and how the former relates to the latter. Beyond that, you are completely free to do what you believe to be best for you, your former spouse and your family.
Most couples in divorce mediation end up doing one of the following:
- Choosing one valuation expert and a valuation method that they can both agree upon. As long as you are in mediation, you aren’t limited to the “intrinsic value” approach favored by the courts.
- Choosing a business valuation formula that they can both agree upon and sharing relevant financial information. They then plug the financial information into the formula and have it reviewed by an independent CPA or one of their own CPAs. In some cases they seek a CPA’s advice about the best formula to use or have the CPA do the calculations for them.
- Treating the business as a “job” rather than having it valued. This usually happens if the business is a sole proprietorship, and there is no legal differentiation between the business and the individual. This also tends to be the case if the business owner’s income is also the basis for spousal support.
If you are thinking about getting divorced or you are considering divorce mediation and you also own a family business, we are here to help. We can begin by giving you the information you need to make fully informed decisions about the best approach to business valuation for you. Once you’ve made that decision, we can help you carry it out. Contact us to learn more today.
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