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Family Business Valuation

Deciding the value of a family business in a divorce defies the certainty of a “ones and zeros” calculation. The only true certainty is that an appraisal will be costly and disruptive – the appraisal depends on the appraiser being a “seer,” who divines the future. Recent events make appraisals even more uncertain. The appraisal must consider COVID’s effects on your business, plus inflation. What does all this mean for your appraisal? First, be very careful about what date of value your expert uses (yes, there are options!). Second, make sure your expert bakes all of this uncertainty into the cake. Here is what you need to know:

No. Although business valuation experts tend to assume that the value becomes fixed on the date of service, this is not automatic. More to the point, an expert choosing the date of service may not benefit you. Divorces involving businesses can take months, if not longer. During that time, the business value may drastically go up, or down. Perhaps the business scored a big, new customer; received loan forgiveness; or saw demand soar. If this is your business, and you want a buy-out, then you want the valuation date to be as close as possible to trial or settlement so it captures growth.

Generally, no. If it is a bad business decision, then both parties will be responsible. That is because any obligation incurred during the marriage is presumed to be a community obligation. If it is not a business decision – such as wasting marital funds on an extramarital affair – the responsible party may be held responsible for the consequences.

A new case just issued by the Court of Appeals (Meister v. Meister) clarifies that the trial judge has lots of discretion when deciding on a fair valuation date. The operative word here is “fair”. Prior to Meister, experts insisted that if business events were not known or knowable on the valuation date (which was typically the date of service), those events should be disregarded. But this approach can result in disastrous and unfair consequences for one party, especially where a business has dramatically increased or decreased after the valuation date. To solve this problem, the Meister court refused to apply this known or knowable standard to family law cases.

Yes. Ordinarily, each party’s compensation from their work becomes that person’s separate property after the divorce petition is served. But deciding what is reasonable compensation as opposed to just plain profits is trickier when you own your own business. You will have to prove what you should have been paid for your efforts. Otherwise, all payments and distributions made by the business after service will belong to the community.

A key component of business value in a divorce is the expert’s prediction how much you, and the business, will earn in the future. To make this prediction, valuation experts must measure future risk. But valuation experts are not psychics. Experts make assumptions about future earnings. Experts may extrapolate future earnings from past earnings. However, in a highly inflationary environment, or a tight materials market, or a pandemic (or all three), past earnings may be meaningless. The expert may have to make some wild guesses. As a rule of thumb, the higher the risk, the lower the value.

Valuation experts in a divorce make assumptions about the tax rate the business owner will pay. The lower the tax rate, the higher the value of the business.

Real estate is in a bubble for now, but many experts “predict” that this bubble may burst – possibly sooner, rather than later. In Arizona, housing inventory has already dramatically increased. If your business depends on the construction or real estate industry or includes investments in these industries, predicting its value even day to day is very risky. If you intend to buy out your ex, you want to value the business as closely as possible to the date that you will actually receive full ownership of the business.

It makes it more difficult. But there are options. You could just compromise on the value based on guesswork. You could also let the valuation issue be decided after your divorce and so the markets settle down. If you go this route, there should be an agreement as to how much the business owner will be paid for their service and how any net profits would be divided. You could sell the business so that each of you shares equally in any upside or downside. Or you could agree to co-own the business for a period of time. These options require careful consideration and should not be attempted as DIY.

If you are already divorced and stuck with paying for a business that no longer has value, your options are far more limited. If you are in this position, don’t just give up. There may be a solution under certain limited circumstances. Consider a consultation with legal counsel to determine if there is any recourse.

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McCarthy Family Law is a full service family law firm that services all family law issues. If you are going through a divorce or have questions about filing for divorce, we are here to assist you. Please call us at 520-623-0341 to explore your options. Turning Stress Into Solutions®.