Application in Divorce
In all divorce actions, the value of marital assets must be determined.
The value of a bank account is easy to determine, but the value of a family business and intangible assets can be much more difficult to ascertain.
If the parties in a divorce cannot agree on the value of, for example, a family business or artwork, a judge relies on the
testimony of experts.
Valuation should not be confused with
classification of assets, such as separate or immune property, marital or community property. Classification of assets is done as an adjunct to their distribution, but assigning a value is independent of classification.
Relying solely on the idea of the
fair market value -- roughly defined as the "price a willing buyer would pay to purchase the asset on the open market, with neither under any compulsion to complete the transaction" -- can create problems in a divorce settlement. Many assets, most notably retirement benefits, are valued at thousands of dollars, yet a willing buyer would be unable or unwilling to purchase them. In general, in divorce actions, the value of an asset is the amount of future benefit the owner will receive.
Closely held corporations, single-proprietor businesses, private companies without publicly traded stock must be appraised or valued by various experts who use different methods to place a value on the business. Many
factors -- including fair market value versus fair value, good will, salaries versus distribution of profits, return on capital -- make this calculation difficult and subject to dispute because these appraisals have a measure of subjectivity.
The problem of valuation is often made more explosive because one
spouse (usually the husband) may be far more emotionally attached to the business, and he may be far more threatened by the cost of holding on. In some cases, part of the value of the business may be separate property and the remainder marital property, as in the case where one spouse had an established business when he or she married, but this facet of a divorce
relates to the classification of assets.
Although valuation of a business can be very difficult, in general there are two approaches that expert witnesses bring to divorce actions to assess
the value of a business. The first is called the total value approach, which separates each asset of the concern and values it separately, and the second is the going concern approach, which treats the business as a complete entity.
In the first, a business is the sum of its parts; in the second, it is a whole greater than the sum of its parts. Both, however, share a common ground, which is the
IRS Rev. Rule 59-60, 1959-1 C.B. 237, upon which courts have relied in determining the value of a business in divorce actions. The rules do not state a single valuation method, but list relevant factors that include: 1) the nature of the business and its history; 2) the general and specific outlook for the business and the industry; 3) the book value and financial condition of the business; 4) the earning capacity of the company and its 5) dividends; 6) goodwill; 7) sales of the stock and the size of the stock in question; and 8) the market price of corporations in similar businesses. A consideration of these factors gives the court a frame of reference by which to weigh the evaluations of experts enlisted by the divorcing parties.
In the total value approach, the assumption is made that the value of a business is the sum of its
assets minus the sum of its liabilities. Assets include physical assets and accounts receivable, and most commonly deals with goodwill in what is termed the excess earnings method. In this routine, the court computes the difference between actual earnings of the business
and the earnings of the "average" business, and then multiplies the difference by a factor of one and five. This calculation is said to capitalize the earnings. In the total value approach, goodwill becomes problematic when it is deemed unrealizable, as is often the case in a single-person operation where the owner’s reputation cannot be transferred.
In the going concern approach, courts can rely on 1) past valuations, particularly those where the owning
spouse has placed a value on his business in an arm’s length transactions with a third party; 2) comparable sales, where the value is compared against past on sales of similar enterprises in the same area as the subject company; and 3) buy-sell agreements, which are contracts between owners limiting the conditions under which interests in the business can be sold. Another method for calculating going concern value is capitalization of total earnings: multiplying the total earnings by a number determined by an expert accountant. Sometimes an approximation of capitalization of total earnings assumes the value of goodwill as equal to one year of gross earnings.
Valuing a marital business can become further complicated by special situations that require special consideration. These situations, which might cause a discount in the valuation, include: 1) partial ownership, when the owning
spouse owns less than the whole business; 2) minority vs. majority interests, which tend to reduce the minority owners’ control of the business; 3) a lack of marketability; 4) lack of voting rights; and 5) "key man," who might leave the business.
In general, the valuation of the
marital home requires an appraisal. When they sell the marital home as part of a divorce, they divide the equity of the house, which is the market value minus the value of any mortgage and other costs associated with the sale. This means they divide the net sale proceeds. In the event of a sale, the real estate commission and other costs are not taken into account unless the sale of the property is reasonably foreseen.
When a couple sell the
marital home as part of the divorce settlement, they usually divide the net sales proceeds and in so doing split the cost of selling -- real estate commissions and related costs -- between them. However, when one spouse keeps the home, normally these costs are not considered in the valuation of the home for settlement purposes and are therefore borne by the spouse who keeps the home when and if it is sold. A majority of courts do not consider these costs in the property division unless they are "reasonably foreseeable." Women, who very often keep the martial house when small children are involved, should be mindful of this. Very often the party who keeps the house finds that he or she cannot afford it or simply no longer wants it.
Buy and Sell Agreement; Closely Held Corporation; Marketability Discount; Fair Value; Fair Market Value; Marital Home.