Business Valuation in Divorce: Everything You Need to Know

A divorce business valuation can feel like pouring gasoline onto an already well-fanned flame. Property division is one of the more demanding aspects of divorce, and the complexity of the assets can create more stress for everyone involved. 

In this article, you will learn how an attorney can help safeguard your most valuable assets and interests during a business valuation.

For many business owners, dividing business assets 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. To save yourself a headache, your best option is to contact an experienced family law firm. The Colorado divorce attorneys at Robinson & Henry will go above and beyond to ensure your contributions to the marriage are reflected in the business valuation and divorce.

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.

Valuing a business for divorce is an art and a science. The process involves evaluating all aspects of the company, including:

• tangible assets, like accounts receivable and equipment

• historical earnings and performance

• growth stage

• future income

• comparable market transaction data

• goodwill, or the value to the parties above tangible assets

In Colorado divorce proceedings, courts use one of three business valuation methods:

• 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, valuing a professional services business using an asset-based valuation would not be appropriate. Let’s look at each of the business valuation methods in more detail.

The asset-based approach measures the fair market value of business assets minus any liabilities.

An asset approach works when the value of a business is derived from assets acquired, held, or sold. 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, obtaining appraisals and valuations of each underlying asset might be too tedious. Therefore, book value is the most efficient method.

The income-based approach focuses on the economic benefit that the business produces. This approach values a business based on the company’s ability to generate future income.

For this approach, a valuation expert typically uses 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 current business value.

The income-based approach is most commonly used to value professional services companies, such as:

• law firms

• engineering firms

• financial advisors

• medical and dental practices

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 its interest. A market approach is useful if there are similar sales of comparable businesses in the market.

Examples include franchises commonly bought and sold around the country. Details of these transactions are often publicly available.

The court has broad discretion to select and apply valuation methods based on the evidence and circumstances of the case. Here are some additional methods the court may use to determine a business’ value during a divorce. 

Excess Earnings Method

The excess earning method is a common technique for divorce business valuation reports. It is a generally accepted approach for determining the present value of a business interest. This method avoids valuing a business based on post-divorce earnings and profits, focusing instead on past results.

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 value as long as it generates a higher revenue stream than the business owner’s income 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)

The first step in dividing business interests during divorce proceedings is determining how much your business is worth. The kind of settlement you and your spouse receive will largely depend on the value of the company.

Business valuation divorce cases are notoriously complex. For this reason, Colorado attorneys typically work with business valuation experts, such as a certified public accountant or a forensic 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.

Next, you will need to provide the court with a comprehensive and accurate financial record for mandatory disclosures, including:

• Tax returns

• Profit and loss statements

• Balance sheets

You will also need to complete a Sworn Financial Statement as well as Supporting Schedules, if applicable, along with an Affidavit in Support of Waiver of Mandatory Disclosures. This information will give the court an accurate picture of the business’s financial condition. 

Colorado law stipulates that any income from self-employment or business operations that reduces personal living expenses, such as reimbursements, is considered income. Hence, the need to be accurate in your disclosures. A review of your financial records for any adjustments ensures personal expenses, non-recurring costs, and discretionary spending are accounted for in your financial disclosure. 

After you have reviewed your financial adjustments, you can proceed to the next step: evaluating business assets and liabilities, including tangible and intangible assets.

Goodwill is an intangible asset that is particularly significant in valuing a business. It represents a business’s value beyond its tangible assets and accounts receivable. 

Next, you’ll want to work with your valuator to review your financial metrics. Analysis of the earnings provides a snapshot of the business’s performance up to the date the marriage is dissolved, protecting the valuation from undue influence after the divorce is finalized. 

Cash flow analysis reveals the business’s capacity for future income generation, which is especially important for businesses where discounted cash flow indicates value.

Your valuator will advise you on whether applicability for discounts for lack of marketability will be necessary for the final business valuation. In some cases, these discounts will significantly impact a business interest’s valuation.

Once your valuation expert has issued a final report, review their conclusions to understand the business’s valuation. 

The court considers an appraiser’s report expert testimony that can be scrutinized to determine its weight and sufficiency. So, double-check it for accuracy. 

Now it’s time to apply your business valuation findings to your case. This report is critical in negotiating a settlement or presenting evidence in court for asset division.

By presenting a thorough and credible business valuation, supported by expert testimony, and an appropriate valuation method, your attorney can make an effective argument for your case. 

If your matter goes to court, the judge has broad discretion in determining a business’s value and can choose between your and your spouse’s valuation to decide an outcome. 

Take In re Marriage of Banning, for example, in which the husband challenged the goodwill valuation of his business on appeal. 

The husband argued that no goodwill of value existed for his wife because his earnings were derived solely from his skill and reputation. 

The court held that goodwill, including the husband’s reputation, customer base, and customer relations developed during the marriage, constituted a marital asset. 

“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,” the court stated. 

The appeals court agreed that the wife’s valuation was more realistic than the one provided by the husband’s expert. 

“It would be inequitable to wife, who also contributed to the marriage, to ignore the value of that goodwill as a marital asset,” the court concluded. In re Marriage of Banning, 971 P.2d 289

– In re Marriage of Banning, 971 P.2d 289, 291 (Colo. App. 1998)

As much as we try to prevent them, issues crop up during divorce proceedings. Here are a few common issues related to business valuation during divorce and how you may be able to avoid them. 

Double dipping in a divorce business valuation refers to a situation where the same income stream is effectively counted twice: once in the valuation of a business as a marital asset and again when calculating spousal maintenance or child support. 

These issues arise when goodwill or future income potential is at stake. 

How to Avoid: Prenuptial and postnuptial agreements with business-related provisions can reduce or eliminate the risk. If neither of these options are available to you, you might consider removing business income from spousal support calculations or setting a limit on how much spousal support can come from the business. 

Hidden assets can arise when one spouse conceals or undervalues assets during the divorce process. Because the court considers full and honest disclosure paramount to a fair valuation, the discovery of hidden assets can lead to disputes and potential legal challenges up to five years after the divorce is finalized. 

How to Avoid: A forensic accountant will look for hidden assets by examining discrepancies between a spouse’s financial records and the business’s records. This can be accomplished by cross-referencing personal and business account records to identify unusual transactions, while also examining lifestyle and net worth to find hidden assets.

Emotional attachment during a business valuation in divorce proceedings refers to the subjective and sentimental value one or both spouses may place on a business. Emotional bias can lead to an inflated or deflated valuation that does not reflect the objective market value of the business. 

How to Avoid: Try to separate the business from the personal as much as possible. This is where hiring a neutral third party to conduct the valuation can help you maintain financial integrity. One way to ensure objectivity is to retain the same individual as your spouse to evaluate the business. 

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 to your spouse’s interest cannot be overlooked.

A business valuation in divorce is a significant undertaking. No matter which side of the dispute you’re on, the Colorado divorce lawyers at Robinson & Henry are well-prepared to protect your business interests and most valuable assets. Call (720) 767-3127 to begin your case assessment.