Where a party, or the parties, own businesses, or interests in businesses, other than shares in publicly held corporations, those interests must often be valued by an opinion statement of a recognized business valuation expert.
In Massachusetts, for example, this is very important not only in determining the equity of the interest held in the business but also in the context of determining alimony and the dreaded (from the payor’s perspective) alimony double-dip – about which more later in this article.
What is a Business Valuation Expert?
A Business Valuation Expert is a financial professional who reviews business information and determines an opinion of value and the proper level of compensation for the occupation of the party. Simple enough? Not really. I use one or two very well recognized individuals when I hire a valuation expert onto a client’s litigation team. And, that is a very important point – the lawyer hires the expert.
The business valuation expert works for the lawyer. There are discovery and possible evidentiary consequences when the expert works for the client directly. But, this article is not a lesson in discovery or evidence. Certified Public Accountants hold advanced accounting degrees, have published industry-related articles and practice in the field of forensic accounting. They are recognized experts in their field and have been qualified as experts before many courts to provide expert testimony. What do they do?
What does a Business Valuation Expert Do?
The business valuation expert collects data in the form of business records, including bank account records, payroll records, spreadsheets, tax returns, and other records. He or she will interview the business owner and the party with the business interest to be valued.
The expert will use industry-specific information to determine whether the party with the interest to be valued is being compensated at the proper rate. Often, in closely held family businesses, a party is paid more than they would be if they worked the same job in a company that was not closely and/or family-owned.
The level of compensation is very important both for determining child support or spousal support that may be paid and determining the value of the person’s interest in the business. For example, let’s assume that a party is a managing partner of a professional firm, like a dentists’ office, or an accounting practice. And, let’s assume that industry-standard income for a managing partner of such a firm is $200,000, but the business owner-spouse in this hypothetical case is paid $400,000 per year.
Assuming that in this hypothetical, should support be based upon the lower or the higher figure?
If all of the compensation is income, then none of the compensation is available to determine asset value. Because, what would a prospective buyer be buying for his or her money when buying the business if the only worth of the business is the income? There is no residual business value. Some businesses are that way, and that it is how the valuation comes out. But, most are not.
To oversimplify the explanation, usually, the “job” of the business owner spouse has a value that is separate and distinct from that part of the compensation that is paid in consideration of the risk and benefits of business ownership – profit.
So, in our example, the value of the job itself is $200,000 and the profit derived is $200,000 for a total compensation package of $400,000. Support often, but not always, is based on the value of the job, and support is calculated on that figure. The profit goes toward the value of the ownership interest, which, is a marital asset to be divided once during the divorce.
This makes sense when you consider a marriage a partnership between the spouses. Once the partnership dissolves, why should the other partner, who is not continuing to contend with the risk of business ownership, share future profits?
In Massachusetts, the law favors the above approach in determining alimony, but it is not required. In other words, there are cases where some or all of the profit may be used to determine support and the asset is still divided between the spouses using some or all of the same money used to determine support.
If this is confusing to you, that is normal. Valuation of business interests in the context of divorce can be complex and litigating the issues of support and asset division can be challenging. Who you select as your lawyer and who the lawyer selects to fulfill the role of business valuation expert are important decisions for the divorce client to make.