Business Valuation in Divorce

As we know, closely held businesses can be subject to equitable distribution in divorce. In order to ensure that any division of a business interest is equitable, an accurate evaluation is crucial - however, determining fair market value of a closely held business can be challenging. In most instances, an expert is required. The expert hired for valuing the business will usually consider a list of factors set forth by the Internal Revenue Service (IRS) in Revenue Ruling 59-60. Those factors are:

1. The nature of the business and the history of the enterprise since its inception.
2. The economic outlook in general and the condition and outlook of the specific industry in particular.
3. The book value of the stock and the financial condition of the business.
4. The earning capacity of the business.
5. The dividend-paying capacity of the business.
6. Goodwill* or other intangible value.
7. Stock sales and the size of the clock of stock to be valued.
8. Market price of similar stocks.

*Goodwill may not be valued and divided in equitable distribution in Mississippi

After reviewing the factors, the business valuation expert will apply one or more of the accepted methods of valuation. These methods of valuation generally assess value by looking at business income, business assets, and comparable sales. Common valuation methods are:

Asset-Based - this approach values a business based on the net value of its assets - equipment, inventory, accounts, real estate, etc. and can be particularly useful in valuing unprofitable businesses.

Income-Based - this approach values the business based on an estimation of a company's future earnings which is calculated through a complicated process of determining the company's "normalized" earnings and investment risk.

Market-Based - this approach determines the value of a business by basing it on the sale of a comparable business. This can be an effective way to determine fair market value when such information is available, however, with many closely held businesses, finding information on the sale of a comparable business can be difficult.

The presence of a closely held business in a divorce can drastically complicate the proceedings. As you can see, getting a business valued accurately is itself a complicated process, but one that is crucial to a truly equitable distribution of the marital estate. Additionally, complications can arise if both sides to a divorce each hire their own expert to perform a business valuation and the experts disagree. If you are facing a divorce and you or your spouse has an interest in a closely held business, it is of paramount importance that you enlist the aid of a divorce attorney to ensure that your rights are protected.

Jonathan T. Day, Esq. is a Divorce & Family Law attorney serving the Jackson, MS metro-area. You can reach him at (601)-707-8953 or jtd@jonathantday.com.

Division of a Business in Divorce

Closely held businesses are subject to equitable distribution during divorce the same as other marital property. However, the form of ownership of the business influences the type of asset available for division. For example, if a business is a sole proprietorship then the business owner owns all of the business' assets himself. These assets could then be subject to division. Whereas if the business were incorporated (an LLC, LLP, S Corp., etc.) the companies actual assets are owned by the business entity - therefore the asset subject to division is the owning spouse's interest in the company.

Under equitable distribution a business interest can be classified as martial property, separate property, or a mixed asset. Only business interests that are determined to be marital (or the marital portion of a mixed asset) are subject to division. Here is how the classifications break down:

I. Separate

A business interest may be classified as a separate property interest if it was owned prior to the marriage, purchased during the marriage with separate funds, or was acquired during the marriage by gift or inheritance.

II. Marital

A business interest may be classified as a marital property interest under a couple of different circumstances:

1. If the business interest was acquired through martial efforts or funds. So if a spouse had started a business during the marriage and built up the business through personal effort, that interest would likely be deemed marital. Also, if a business interest was purchased using martial funds it will likely be considered marital property.

2. If the interest was acquired via joint loans or secured by marital assets. If a business was created/purchased/expanded with a loan that both spouses are obligated to repay, or if marital property was used to secure the loan, then that business or business interest would likely be considered martial and subject to division.

3. If separate business funds "commingle" with marital funds. An otherwise separate business can be converted into a marital asset if marital and business funds are extensively commingled. Such an example might include having marital funds in business accounts, business funds in martial accounts, and using separate business funds to pay for martial debts and expenses directly.

III. Mixed

A business interest may be classified as a mixed asset - or an asset that is martial in part and separate in part - for a couple of reasons:

1. The business interest was acquired both during and outside of marriage. For an example of such a scenario, take a look at the case Pittman v. Pittman, 791 So. 2d 857, 865 (Miss. Ct. App. 2001), in which a spouse worked without pay for a year in a business to earn a 5% interest in the business. Only a portion of that time would be classified as marital, and so only a portion of the 5% interest would be classified as a marital asset.

2. The value of a separate property business appreciates during the marriage. A business that was owned prior to marriage as separate may be classified as mixed if the business appreciates in value during the marriage due to the owner spouse's efforts during the marriage. However, if the appreciation in value is due to forces other than the owner-spouse's efforts - such as inflation, or third-party efforts - the entire asset remains separate and the appreciation in value will not be classified as martial.

As you can see, owning a business or having an interest in a business can greatly complicate a divorce and property distribution. If you are a business owner or self-employed and facing a divorce, it is crucial that you speak with a divorce and family law attorney. Having a business interest appropriately valuated and allocated can drastically alter the balance of power in negotiations and impact any proposed property settlement agreement.

Jonathan T. Day, Esq. is a Divorce & Family Law attorney serving the Jackson, MS metro-area. You can reach him at (601)-707-8953 or jtd@jonathantday.com.