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Business Valuation in Divorce Proceedings
Divorce proceedings and the judicial infrastructure that governs them are inherently complicated, particularly when one or both of the parties own a business. Contingencies must be juggled, extenuating factors, such as a buy/sell agreement, must be measured, and all interests must be weighed. Insofar as the Family Court bench and the attorneys who appear before them are not experts in business valuation, the credibility of the valuation expert’s testimony and supporting valuation report become the basis for a judge’s or mediator’s decision regarding the value of a business. The valuation expert must not only have the right answer, he must have the respect of the judiciary.
The threshold consideration for any valuation expert is the selection of a standard of value appropriate to a particular business. United States case law varies on the suitable standard of value depending on the state, and in some cases even the county of the divorce proceeding. The attorney and the expert should agree on the standard of value prior to beginning the valuation, to mitigate ambiguity and strengthen negotiations.
Marital dissolution creates stressful circumstances that frequently require the hypothetical sale of a business. As in any other valuation, the threshold and critical consideration is determining the standard of value at the outset. For example, the Fair Market Value (FMV) method of quantifying the worth of a business contemplates a hypothetical sale, a voluntary arm’s length transaction with a willing buyer and a willing seller, under no obligation to act, that also considers discounts for lack of control and lack of marketability. Another viable and frequently explored option is what is known as “Investment Value,” or owner’s value. This calculation references the value to the business owner based on individual investment requirements.
According to Shannon Pratt, a respected valuation expert and author, in his article titled “What is Value” – “in marital property divisions, only a few states strictly adhere to “fair market value” as defined, many more states lean toward what the business appraisal community defines as investment value.” In the context of a divorce, investment value represents the value of the interest in the owner’s hands with no contemplation of a sale. Therefore, while a valuation utilizing the Investment Value standard requires consideration of all the same elements of an appraisal listed in the Internal Revenue Service Ruling 59-60, it ignores discounts for minority positions and marketability that would otherwise disproportionately benefit the business owning spouse.
Clearly, the valuation professional must be aware of the prevailing case law regarding the standard of value in their respective State as there is not consistent treatment of valuation issues on a national level. Because every jurisdiction’s financial terminology is as varied as the Family Court Judge’s discretion, it is essential the attorney and valuation professional begin their relationship early in any divorce proceeding requiring the division of a business asset.