During the provisional process of divorce, courts will exercise discretion when assets, liabilities, income, and other factors are brought forth for equitable distribution. Property is classified as either marital or separate, and the marital property is then valued and distributed between both spouses. While most simple assets and liabilities are agreed upon or easily divided, business interests are far more complex.
With one or more parties involved in the family business, accurate calculations are important not only for purposes of asset division, but to prevent future legal issues.
How to Determine Division
Prior to determining business value based off assets and liabilities, courts will determine divisibility by considering how the business was formed. If it was started prior to the marriage with funds brought in by one spouse, or if the business was started during the marriage with non-marital funds, the assets are considered separate. However, if the business was started with marital funds by one or both parties, the assets are considered marital.
There are situations in which businesses started prior to marriage with non-marital funds could be considered marital property, however.
Let us assume Bob opened a successful casual shoe store with $50,000 of his own money. He then married, carrying over that income into his marriage. However, he needed to use $30,000 of marital funds to launch an online advertising campaign, which significantly increased sales and income. The first $50,000 of his business’s valuation would be discounted; the $30,000 borrowed plus any income derived from that ad campaign would be split 50/50 since growth relied upon the use of joint funds prior to divorce.
Undervaluation can cause future suits or claims of fraud against the business owner, so it is important to take this next phase seriously.
How to Determine the Value of a Business
In calculating business interest, one of three approaches may be acceptable:
- Income approach. Most calculations are based off the income approach. By plugging future profits and cash flow into a predictive formula, an expert can determine what the current value is based off future market position and expected sales volume. The formula used takes into consideration risks and losses.
- Asset approach. This simple method of computation takes assets, subtracts liabilities, with the resulting number being the value. Both intangible and tangible goods are taken into consideration. Inventory, which will vary based off fair market value, will be determined at its current net worth during the divorce proceedings. Usually the same holds true with vehicles and real estate.
- Market approach. By comparing the divorcee’s business with similar businesses, a market estimate can be used to determine valuation. Think of how realtors estimate home values based off comps, or the current value of neighboring homes.
An outside expert should be retained (and normally is) to work alongside your divorce attorney if the business is expected to account for a significant portion of total marital assets.
Why Should Calculations Happen During Divorce?
Even if the non-owner spouse agrees to amicably resolve personal and business property without extensive calculations, it will behoove the business owner to hire an outside CPA and/or similar expert to work on valuation and a high-asset divorce attorney who can attempt to evaluate the expert’s final assessments. Undervaluation could come back on the business owner later if the non-owner concludes, rightly or wrongly, that assets were being hidden to avoid paying fairly.
High-asset divorce cases rely on accurate valuation of marital assets to protect the interests of both parties. Shielding assets during the judge’s equitable distribution of marital property may not only lead to civil liability but could have criminal implications.