A business is often a marital asset that is subject to division in the divorce process. Depending on your state, a marital asset, like a business, will be divided equally or equitably. An equitable division may not be completely 50/50 but it is often pretty close.
In order to divide a business, the court first must know the business’ value. In many instances the business is the family’s main source of income and the largest marital asset. Therefore, determining the correct value of a business is extremely important. There are multiple approaches to valuing a business and certain valuation methods are better for different types of business. Different business valuation methods, include:
- Asset-based valuation
An asset-based valuation bases the value of a company on the value of its assets. That value is found either by the book value as evidenced by the “owner’s equity” on the balance sheet or the liquidation value which is the value of the assets if you sold them “as is” immediately. This is the most conservative method of valuing a business and will generally give you the business’ lowest value.
- Historical earning valuation
A historical earning valuation takes into consideration a company’s good will and future earning ability. The theory behind the historical earning method is that the past history of business earnings will provide an estimate of the company’s past rate of growth and future earning potential. In examining the historical earnings of a company, a business appraiser looks at the company’s debt paying history or the company’s cash flow history.
- Assets and earnings valuation
An assets and earning valuation, often referred to as the excess earnings method, looks at both the value of the assets and the historical earnings of the company. This method is commonly used for gift tax valuation purposes and the IRS does not allow this method to calculate the value of a business for some purposes.
- Future earnings valuation
The future earnings valuation method is used to establish a value for larger businesses in merger and acquisition situations. Valuations that estimate the future profitability of a small business, however, are not very reliable because the appraiser is required to make many estimates and projections. These estimates and projections don’t consider unforeseen circumstances.
If you are going through a divorce and you, or your spouse, own a small business, it is important to have an experienced family law attorney on your side. A divorce attorney skilled in the financial side of the divorce process will work with the business appraiser and ensure that the valuation method chosen provides the most accurate value to the business.