3 Common Issues When Valuing A Business In Divorce

A complex aspect in a divorce is the division of marital property. The court, together with valuation experts and the lawyers of both spouses, have to determine the value of the property before it can be distributed between spouses. Some properties, such as a bank account, have a straightforward value. But others, such as a business, often require a complex valuation process.

Let’s first have a quick overview of a business as marital property. Under Colorado law, any property that you and your spouse co-owned, or any property that either of you owned during your marriage, is considered marital property. A clear example would be a business that you and your spouse jointly owned as a couple.

What if the business was already owned by one of you before getting married? If the value of that business grew duringyour marriage, then that increase in value – not the business per se – would be considered marital property.

Once the court has decided that the business, or at least part of it, is marital property, the next step would be determining its value. When valuing a business during your divorce, be aware of these common issues that may arise.

Standard Of Value

Defining the standard of value is the very first step in business valuation, but it can also be the most difficult. To understand this better, we can take a look at two generally accepted standards of value in divorce cases: fair market value and fair value.

In a nutshell, fair market value (FMV) is the price at which the property would hypothetically be sold if the buyer and seller are both unpressured and both reasonably knowledgeable. FMV typically applies discounts. Fair value, on the other hand, is largely similar to fair market value, except it does not apply discounts.

With this small difference, these two standards of value would produce two significantly different valuations of the same business. This is why it is crucial for all parties in a divorce to agree on the most appropriate standard.

In some jurisdictions, the standard of value used is dictated by law. However, Colorado law has not specified one definite method for business valuation during divorce. This leaves more room for disputes along the way.

Double-Dipping/Double-Counting

The term “double-dipping” refers to the notion that one spouse is awarded two amounts from the same business – once during the division of property, and another during the calculation of alimony or child support. This can occur when the business valuation uses the income approach.

Under the income approach, the valuator or appraiser determines the value of the business based on the income it is expected to make in the future. A business may be fairly divided this way during divorce. When it comes to determining spousal support or child support, however, the same future income stream will likely be used as a basis again. This is why some consider double-dipping unfair.

Fraud

We often hear of people committing fraud through sophisticated methods, such as business scams and identity theft. But fraud during the division of marital assets can be more subtle or even simple. Some of the common frauds that occur during business valuation include concealing or undervaluing its assets, understating its revenue, and overstating its expenses.

Here’s an example. During the divorce of a housewife and her husband, a part-owner of a software company, the husband presented a financial affidavit that reflected his $50,000 salary and $40,000 ownership interest at the time. The marital property was divided based on this affidavit.

The husband, however, did not disclose that he had been getting substantial offers for his share of the company. After the property division was finalized, he sold his share for millions of dollars, which showed how greatly he had undervalued a business asset during the divorce. The wife had to pursue a ten-year legal battle before getting a settlement.

Business valuation during divorce is definitely a legal maze riddled with technicalities, loopholes, and points for dispute. It is wise to have a reliable family law attorney by your side throughout the process. In this way, your rights and best interests are protected, and you have knowledgeable guidance towards making your best choices.