The Basics of Business Valuation

Norris Family Law

In some cases, the community estate – in other words, all the marital assets – includes a business. In general, an equal division of the business must be predicated on fair market value. But determining what the fair market value of a business can be complicated.

Sometimes when a community estate includes a business, people going through divorce might decide to have the business valued by a forensic accountant, or by a professional appraiser knowledgeable about the particular type of business at issue. Each side can hire their own forensic accountant; or, you and the other party might decide to jointly retain a forensic accountant, in which case you can also decide either to be bound by the joint expert’s opinion, or to retain the right to bring in your own expert later on should that become advisable.

Valuation approaches differ based on the nature of the business or professional practice and the purpose for which the valuation is conducted. For example, the valuation of a small dry cleaning business might utilize a very different approach from that of a partnership interest in a large executive search firm. Especially with all the new types of businesses that have been created in recent years, for example in the technology field and the financial sector, you might wonder what your business is “really” worth.

“Book value”, “going concern value”, “discounted cash flow analysis”, “excess earning”, “goodwill”… these are all accounting terms you may have heard of which are used in connection with business valuation.

The following are some basic concepts used in determining a business’ worth. This information is by no means a complete exploration of these concepts, and you should discuss the matter with your attorney if you have questions.

“Asset valuation” focuses on the total assets a of a business, minus the liabilities. This type of valuation might be used where a business is going to be liquidated. “Book value” looks to the amounts paid for various assets and takes into account their depreciation. “Excess earnings valuation” or “capitalized earnings valuation” focuses on the earning power of the business to determine a rate of return.

“Goodwill” is an intangible component of the business’ value, and results from the owner’s skill, reputation, and the expectation of continued patronage by existing clients or customers. Goodwill is often the element of a valuation of a commercial business or a professional practice that is most susceptible to differing opinions.

It is important to realize that courts are not limited to any one valuation method. Two forensic accountants utilizing different business valuation approaches might arrive at very different values for a business. Each case is unique and which approach you use — whether you hire your own expert, retain a joint expert with the other side, agree to a value without using expert opinions, or some other approach — depends on the facts of your case.

Divorce and Retirement Accounts

An often asked question is: Now that I am getting divorced, what happens to my/our retirement accounts?

This can be a complicated issue, but generally speaking, pre-marriage and post-separation retirement benefits remain the property of the spouse who earned or acquired the benefits. Benefits earned or acquired during marriage, however, are community property, owned by the parties 50-50. Given that most people continue to make contributions to their preexisting retirement plans after they are married and after separation, most retirement accounts and pensions contain both separate and community property.

How does this all get sorted out? Sometimes it is a fairly straightforward matter, but more often an actuary is retained to calculate the separate vs. community property portion of retirement plans/accounts.

Certain retirement accounts must be divided according to a Qualified Domestic Relations Order (QDRO), which creates an alternate payee and assigns the alternate payee the right to receive plan benefits otherwise payable to the plan participant. IRA’s, on the other hand,  can be divided without a QDRO.

Each case is different, and the attorney in charge of your case will advise you on how to proceed.

Financial Awareness is Critical in a Divorce

A situation that we commonly see when a person comes to us for advice about divorce is that he or she has let the other spouse handle all the financial affairs throughout the marriage and is therefore not knowledgeable about the couple’s finances. This used to be almost exclusively a problem for wives, but we are now finding it is sometimes the husband who is in this situation (when the wife has been the primary career person). Here are some thoughts to keep in mind:

Even though you are intelligent, even though you are financially comfortable, even though you think you will never need to be financially savvy, you need to protect yourself—through knowledge and information.

Know where all the account records are (bank statements, brokerage account statements, IRA and 401K statements, and records of investments). Keep them in a safe place.

Retain copies of all tax returns, including all schedules and attachments.

Check on whether your name is on all real estate, and keep the deeds in a safe place.

If your spouse is employed, retain copies of pay stubs (especially year-to-date stubs).

Retain copies of all estate-planning documents, including wills and living trusts.

Know how to gain immediate access to safety deposit boxes.

If you have received an inheritance or any large gifts, keep the records (copies of the checks, letters of transmittal, or other transfer documents) in the event that you will one day need to trace back to them.

If you want to retain an inheritance or large gift as your separate property, keep it in an account in your name alone, and do not commingle it with joint funds.

If all of your charge accounts are joint, obtain one or more charge cards in your name alone.

Prepare a list of your monthly expenses, and your family’s monthly income, so that you can see how much is coming in each month, and how much is going out.

Know what financial records are on your home computer, and know how to access and copy them.

The above information is important not only for your own financial knowledge, but it is also important information for you to give to your attorney should the need arise.

 A Stock Option Primer

Stock options in California are considered a form of employee benefit that is property subject to division upon divorce.  This means that options granted between the date of marriage and the date of separation are community property, wholly or in part.  Since community property is what results from a spouse’s work efforts during marriage, and since options are subject to a vesting schedule (i.e., in order to receive the value, the employee has to continue working at the company until the vesting date of the applicable traunch of options), options may be wholly community property, or partly community property and partly separate property.  This means that, as a general rule:

Options that are granted during marriage, and that vest during marriage, are  community property;

Options that are granted before marriage, but that vest during marriage, are partly separate property (because of the premarital period), and partly community property (because of the vesting during marriage); and

Options that are granted during marriage, but that vest after the parties separate, are partly community property (because of the marital period), and partly separate property (because of the vesting after separation).

In dividing options as part of a divorce, the court must apportion the separate and community interests in the options.  There are no set formulas, no hard and fast rules, as to how this is to be done.  Rather, the court has broad discretion to use the formula that is appropriate given the facts of the particular options.  There have been a number of appellate cases addressing various formulations of a “time rule” approach, based upon significant features of the options at issue.  The court must come up with an equitable formula that considers whether the options are rewarding services to the company during the marital period (community), or during the periods either before marriage or after marriage (separate).  Each traunch of options that vests can be all community, all separate, or apportioned between (i.e., a combination of) both.

There are many common misconceptions.  Here are a few of them.  It is not true that the grant date controls the characterization.  It is not true that options granted before marriage are all separate property, even though they vest during marriage.  It is not true that  options vesting during marriage are all community property, even though the option grant was before marriage.  It is not true that options vesting after parties separate are all separate property, even though the option grant was during marriage.

It is important to remember that there are no hard and fast rules about what formula is to be used.  When options are at issue in a case, option agreements, grant notices, and vesting schedules must be obtained and analyzed so that a party’s attorney will be in a position to determine characterization and, where apportionment is required, present the most appropriate formula.

 Should You Move Out of the Family Residence?

When a person is contemplating a divorce, or has filed for one, a difficult decision often is whether to remain in the home, or to move out.  This is a complicated question with many facets.  There is the financial one:  Can we afford to maintain two residences while the divorce case is being resolved.  There is the parenting one:  Will I hazard my custodial rights if I move out and the children remain with the other parent?  There is the property one:  Will I be giving up any of my rights to property?

Financially, reality may dictate that the parties must remain in the same residence, at least for a time.  Most persons, however, find it emotionally very difficult to live under the same roof while a divorce is taking place, and this is usually true even if the parties have done their best to divide the living space to try to minimize interaction between them. 

If financially feasible, it is usually advisable to establish separate residences, but care should be taken that by doing so parenting rights and property rights are protected.

If you have children and you move out of the house without them, unless your spouse is completely cooperative in sharing the children, your time with them is likely to be significantly reduced.  This could affect the long-term visitation and custody rights you are granted.  Your spouse may assert that you voluntarily left, that he or she is the primary caretaker parent, and that this status quo should be continued.  For this reason, it is generally advisable prior to moving out that, if possible, you and your spouse reach an interim understanding as to how the children’s time will be shared after one parent moves out.  This understanding should be in writing and signed by both of you.

With regard to property, whether something is community property or separate property depends on legal rules of characterization and is not determined by whether separated persons are living under one roof or in different residences.  You should be aware, however, that as a practical matter, personal property items (like furniture) that is left behind often wind up being awarded to the spouse who has remained in the house, if he or she ends up keeping the house at the end of the divorce case.  This is often true for the simple reason that the expense of arguing over the personal property turns out not to be worthwhile.  This is because personal property for divorce purposes is assigned “resale” or “garage sale” value.  The spouse who moved out may then receive a monetary offset to compensate for the value of the items.