Business Valuation for Divorce
Divorce is an inherently messy process. Dividing a business during divorce proceedings can feel like pouring gasoline onto an already volatile situation. In this article, you will learn how an attorney can help safeguard your business interests during the business valuation process.
Learn More About Business Valuation During Divorce
Dividing business interests in a divorce settlement can be as complicated as it is contentious. Not to mention, the way the business is ultimately divided will have long-term implications for your finances. The Family Law Team at Robinson & Henry will go above and beyond to ensure your contributions to the marriage are reflected in the business valuation. Call 303-688-0944 to start your free case assessment.
How Colorado Divorce Courts Divide Business Interests
Under Colorado law, any property owned by you or your spouse during your marriage is considered marital property. Business interests are considered marital property and therefore must be divided equitably as required by Colo. Revised Statute § 14-10-11. For a quick breakdown, take a look at this infographic: Business Valuation for Divorce
A clear example would be a business that the two of you jointly own together. However, the process gets more complicated if either you or your spouse owned the business before you were married. If the value of that business increased during your marriage, then that increase in value would be considered marital property.
In a business valuation, a judge may consider:
- when the business was started
- the role each spouse played in increasing the value of the business
- any financial investments either spouse made in the business
- the amount of time and effort each spouse gave to build the business
- any liabilities pertaining to the business
- whether the business is a significant income source to one or both parties
Valuing the Marital Business
Hire a Valuation Expert
The first step in dividing business interests during divorce proceedings is to determine how much your business is worth. The kind of settlement you and your spouse receive will largely depend on the value of the business.
Business valuation divorce cases are notoriously complex. For this reason, Colorado attorneys typically work with a valuation expert, such as a certified public accountant, to obtain an objective estimate of the company’s value. These experts will produce a detailed report to be presented in business valuation divorce proceedings.
Business Valuation is More Than Monetary Value
Valuing a business is both an art and a science. The process involves evaluating all aspects of the company, including:
- tangible assets, like vehicles and equipment
- historical earnings and performance
- growth stage
- future earnings
- comparable market transaction data
Methodologies for a Business Valuation
In Colorado divorce proceedings, courts use one of three basic approaches to value business interests:
- asset–based valuation
- income-based valuation
- market-based valuation
The valuation methodology used depends on the type of business being valued. For example, professional service companies usually have minimal assets and derive their value primarily from income. So generally, it would not be appropriate to value a professional services business using an asset-based valuation. Let’s look at each of the valuation methodologies in more detail.
Asset-Based Business Valuation
The asset-based approach measures the fair market value of a company’s assets minus any liabilities.
This approach works for companies that derive their value from acquiring, holding, and selling assets. A real estate holding company is a common example of a business that would be best valued using an asset-based approach.
The book value of a company’s assets is quickly discernible, but the fair market value of each asset is much more accurate.
Still, it might be too tedious to get appraisals and valuations of each underlying asset. Therefore, book value is the most efficient way.
Income-Based Business Valuation
This approach focuses on the economic benefit that the business produces. The income approach values a business based on the company’s ability to generate profits in the future.
For this approach, a valuation expert will typically use historical financial data to project the company’s future earnings. Those projected future earnings are then discounted back to net present value to determine the company’s current value.
The income-based approach is most commonly used to value professional services companies. Examples include law firms, financial advisors, and medical and dental practices.
Market-Based Business Valuation
In the market-based approach, the business is valued at the price that a buyer on the open market would pay to acquire the business or business interest. This approach is useful if there are comparable sales of similar businesses in the same demographic.
Good examples would include franchises that are commonly bought and sold around the country. Details of these transactions are often publicly available.
Other Ways to Value a Business
Use a Combination of the Methods
A good business valuation will compare all three approaches to determine a final value or value range.
Let’s say you are an interior designer, which is a very personalized business. What is the market value to a willing buyer? Close to zero. What about your tangible assets? Also close to zero.
Still, the business has value — otherwise you wouldn’t do what you do. Therefore, it is a marital property that must be assigned a value. This is where courts use the capitalization of excess earnings method. This approach blends the asset-based and income approaches.
Excess Earnings Method
This approach is a common technique for divorce business valuation reports since it allows for a simulated value of goodwill.
“The excess earnings approach capitalizes the amount by which the attorney’s historical earnings exceed that which an attorney with similar education, experience and capabilities earned during that period. This method results in a valuation that represents the value of both the tangible assets and goodwill of the husband’s partnership interest on the dissolution date.”
In re Marriage of Huff, 834 P.2d 244, 256 (Colo. 1992)
Goodwill in Business Valuation
Goodwill refers to intangible assets that supplement the earning capacity of another asset, business, or profession. It reflects not simply a possibility of future earnings, but a probability based on existing circumstances. In re Marriage of Bookout, 833 P.2d 800, 802 (Colo. App. 1991)
Even a highly personalized small business with no assets has a value, as long as it generates a higher revenue stream than what its owner could earn as an employee working for a third party.
Essentially, if the business is valuable to you, it’s valuable to the marriage. And if the marriage is ending, courts must determine the business’s value to the marriage.
A Colorado appeals judge wrote in one 1979 case that “while professional goodwill is not an asset which has an independent market value, it can, in conjunction with the assets of the practice, be sold.”
“The underlying theory is that an ongoing business has a value greater than its fixtures and accounts receivable. Such goodwill has been defined as the expectation of continued and repeated public patronage. Professional practices that can be sold for more than the value of their fixtures and accounts receivables have salable goodwill. A professional, like any entrepreneur who has established a reputation for skill and expertise, can expect his patrons to return to him, to speak well of him, and upon selling his practice, can expect that many will accept the buyer and will utilize his professional expertise. These expectations are a part of goodwill, and they have a pecuniary value.”
In re Marriage of Nichols, 43 Colo. App. 383, 383, 606 P.2d 1314, 1314 (1979)
Courts Can Rely On One Spouse’s Valuation Over the Other
In one 1998 case, the divorcing spouses each hired their own valuation expert. The trial court found that “the valuation performed by wife’s expert … was more realistic than the valuation performed by husband’s expert.”
The husband argued that no goodwill existed in his business because “when the earnings of a spouse are derived solely from the spouse’s own skill and reputation, and those earnings would not be affected in any way by leaving the business in which the spouse is working, no goodwill exists in the ongoing business, or at least none that is of value to the spouse.”
A Colorado appeals judge disagreed:
“The mere fact that husband could leave the existing business, and start again with a different name, location, or even business structure without impact on his earnings does not mean that no goodwill exists of value to the spouse. Even in a new business, husband would retain his reputation, his customer base, and his customer relations, all of which were developed during the marriage. These together constitute goodwill that supplements, and is distinct from, husband’s earning capacity.”
In re Marriage of Banning, 971 P.2d 289, 291 (Colo. App. 1998)
Now let’s take a look at another example of a Colorado business valuation in a divorce.
In re Marriage of Durie
Steven and Kelly Durie were a Colorado couple who decided to end their marriage in April 2014. Together, they retained an expert to value their businesses: Coin Toss, LLC, a holding company, and the two companies owned by Coin Toss — Rock Paper Scissors, Inc., d/b/a Secure Search, and Sandbox Sharing, LLC, d/b/a Safeguard from Abuse.
The joint expert reviewed materials provided separately by Steven and Kelly. He also considered discussions he had with each of them. Based on his valuation, the joint expert estimated that the companies had an investment value of $855,000 and a fair market value of $770,000.
Kelly then retained her own expert to review the joint expert’s report. Kelly’s expert valued Coin Toss at $919,616. Based on the two experts’ valuations, the couple agreed to value the holding company at $878,589. The separation agreement allocated Coin Toss to Steven as his sole and separate property. In turn, Kelly received a payout of $338,548.
$6.9 Million Post-Decree Sale Prompts Legal Action
Over a year later, Steven sold a portion of Secure Search’s assets to a Tennessee company for $6.9 million. This price tag was more than 685 percent higher than the value assigned to Coin Toss in the separation agreement.
The transaction reminded Kelly that Steven had traveled to Tennessee during the couple’s divorce proceedings. Suspicious, she filed a motion in a Douglas County district court to reopen the property division.
Kelly asked the court to reallocate the proceeds from the post-decree sale. In her motion, Kelly further alleged that Steven had “engaged in negotiations to sell a portion” of Secure Search’s assets before the separation agreement was executed and possibly before the joint expert’s valuation was completed.
Kelly also alleged that Steven had “failed to disclose and intentionally concealed material facts that impacted the value of the parties’ business[es] and the valuation” of the joint expert “and/or [had] failed to update the information to [the joint expert] or Wife once those negotiations commenced.”
In response, Steven filed a motion to dismiss. He denied engaging in any negotiations related to the post-decree sale before 2015. Steven claimed instead that the sale sprang from an “out-of-the-blue” email from the Tennessee company’s senior partner.
The State’s Highest Court Weighs In
The district court dismissed Kelly’s motion, but she appealed the decision. The case eventually made its way to the Colorado Supreme Court, which reversed the district court’s decision to allow her request to conduct discovery into her ex-husband’s actions:
“The ocean of difference between the joint expert’s valuation of Coin Toss and the post-decree sale price for a portion of Secure Search, alone, raises red flags about Husband’s pre-decree disclosures. When that chasm is considered objectively and in conjunction with the other circumstances present — including the temporal proximity between the separation agreement and the post-decree sale, Husband’s travel to Tennessee around May 2014, and Husband’s intimate familiarity with Secure Search — it becomes clear that Wife’s allegations are sufficient under the standards and procedures we endorse today to justify granting her request to conduct discovery.”
In re Marriage of Durie, 2020 CO 7, ¶ 41, 456 P.3d 463, 473
Talk to a Divorce Attorney About Your Business Valuation
If you own a business, you likely spent years building the value of your business, working long hours, and making many sacrifices. This is both your legacy and your livelihood. You should do everything possible to keep it intact after your divorce is final. Likewise, if you were married to a business owner, your contributions cannot be overlooked.
No matter which side of the dispute you’re on, the Family Law Team at Robinson & Henry is well prepared to protect your business interests. Call 303-688-0944 to begin your free case assessment.