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Business Valuation in Divorce


When couples divorce the assets of the marriage must be assessed so that they can be divided. In Nevada, assets acquired during the marriage are community property. Community property will generally be divided equally here in Nevada. Some assets are easy to value of course. For instance, we can easily value a bank account by looking at the most recent statements of that bank account. Some assets are more difficult to value. One of those more difficult to value assets is a business. In many cases a business will not need to be valued. For instance, if the value of the business is entirely related to the value of its chief employee, one of the divorcees, then the business likely doesn't require valuation. Moreover, if the business is a new business without a strong "good will" component then valuation likely won't be required.

However, for those business that do have value which is separate and apart from the value that the litigating spouse provides, a valuation may be in order. Generally speaking, though not necessary, valuing a business requires the expertise of an expert. This is especially true for larger organizations which have been around for some time. To value a business we first must have an understanding of some general terms. One of these terms is "fair market value". Fair market value is defined as the price at which a property would change hands between a willing buyer and a willing seller when the former is not under any compulsion to buy and the latter is not under any compulsion to sell. Both parties are assumed to have reasonable knowledge of relevant facts. "Fair market value" is the most commonly cited standard of value. Understand that when making a fair market value determination the expert does not need to look at an actual contemplated sale to determine market value. The valuation simply looks at what a hypothetical sale would provide. The amount of money that the sale would hypothetically bring in need be in cash or cash equivalency. So for instance, if you are looking at the sales of other similar businesses to get an approximation of the potential sale value of this particular business you will need to take note not only of the full sale amount but also how the acquisition was made. If the business you are comparing was purchased with financing over time then your expert will need to make adjustments to the total sale price by assuming that the purchase was not seller financed but rather was purchased with a lump sum of cash. In this example, this would require a reduction of the actual cash needed for the transaction to take place.

When making value determinations under the fair market value approach it is important that special motivations of buyers and sellers not be included in the calculations. For instance, a certain buyer may be willing to pay a premium because that specific buyer anticipates certain synergies which may only be realized by his purchase of the business, given the buyers existing resources. These types of inflated prices need to be excluded when making valuations. This is because these specific circumstances of one buyer will not apply to the typical buyer.

Also, keep in mind that under the fair market value approach it must be assumed that neither the buyer nor seller is under any pressure to buy or sell. Per the fair market value approach the business is valued as a going concern, not as an asset to be liquidated. Another core concept of the fair market value approach is that both the buyer and seller are assumed to have reasonable knowledge of all relevant facts regarding the business. This means that the parties are assumed to knows all facts which are discoverable through reasonable investigation.

There are times when fair market valuation may not be the proper valuation method. In these cases we may use other valuation methods such as "investment value" or "intrinsic value". "Investment value" is different from fair market value in that it takes into consideration the value perceived by a specific buyer based on that buyer's special circumstances. For example, one buyer may be willing to pay a premium for a business if that buyer anticipates potential synergies between the buyer's existing resources and the newly acquired business. These synergies would not be realized by the typical buyer. "Intrinsic value" on the other hand is value that is perceived by the owner of that business. This intrinsic value does not take into consideration the marketability of the business. So for instance, even if the business cannot be sold let's say because the ownership is non-transferable, such as stock options, the interest can still be valued by estimating the "intrinsic value" to the owner of that business interest.

When valuing a business the term "goodwill" will invariably come up. Goodwill is that part of the business valuation that is likely the most difficult to value. For instance, we can easily appraise the tangible assets of a business to determine the current value of those assets. We can also quantify accounts receivable and accounts payable. Goodwill is an intangible asset that arises when one company acquires another and pays more than the net value of the purchased business's assets. This premium is the goodwill portion. When we do a business valuation we don't actually sell the business. The valuation is based on a hypothetical sale. Thus we have to estimate that goodwill portion of the business's total value. Goodwill might also be called the reputation that a business carries with it. If the goodwill is attached to the business then even when the partner or employees interchange customers continue to purchase products and services of the company. That reputation is the goodwill component of the business. Note that if the goodwill is attached only to the individual then when that individual leaves the business the business loses that much value. Thus when we conduct a business evaluation it is important to look to see how much goodwill is attached to the practice as opposed to the individual. That amount of goodwill which is attached to the practice is part of the business's value and thus subject to quantification for division of community property.

Keep in mind there will be times when partnership agreements and so forth will restrict an individual from selling the business or his interest in the business. Given the fact that the business interest is indivisible the fair market value approach may not be practical. To value the business or business interest in this circumstance it is proper to value of the business as an ongoing concern to the spouse business owner. When this is the case we may need to look to the intrinsic value of the business to the owner.

Be advised that different states apply different valuation methods for valuing businesses. Be sure to look at the statutes and case law of your specific state to get an idea of what method your state uses for business valuations. If you or your spouse own a business and are contemplating divorce be sure to call Eric Roy Law for a consultation on the matter.

For more information on this subject I direct you to Miles Mason, Sr.'s work. He is a JD and a CPA and has written thoroughly on these subjects. Most of my learning such as the information provided above comes from his mastery and writing on the subject matter.

Categories: Family Law