In today’s economy, it is more and more common for divorcing couples to struggle with the valuation and division of a small business as part of the divorce process. Remember, even if the ownership interest is in the name of only one spouse, it may be marital if it was acquired, improved upon, or financed during the marriage.

Often, only one marriage partner is actively involved in the business. That partner will generally underestimate the value of the business or business interest as part of the divorce process. The other party may not seek an independent appraisal under the misguided belief that the appraisal will cost too much electing, instead, to rely on the estimate of their spouse. This can be financially disastrous.

This risk was illustrated clearly in a much publicized case in Hennepin County District Court, Minneapolis, Minnesota. In that case, Debra Sax married husband Paul Taunton in 1994. Taunton was the owner of a company called Athletic Fitters, Inc. (AFI). During the marriage, Taunton is alleged to have repeatedly told Sax that AFI was worth $6 million and that his income was between $250,000 and $300,000 per year.

In 1997, Taunton filed for divorce and the parties decided to get the divorce proceedings over with as soon as possible. In that proceeding, Taunton stated that his income was $250,000 and that AFI was worth $6 Million. Relying on those representations, Sax agreed to a property division and the divorce decree was entered in October of 1997. Fast, simple and civil, right?

Wrong!

Less than four months after the divorce, AFI was sold for $30 million, five times more than the Company was worth. Moreover, investigation after the divorce revealed that Taunton’s Annual income was not $250,000 to $300,000 but ranged from $900,000 in 1994 to $4 million in 1996. Sax subsequently brought a lawsuit against Taunton’s divorce attorney, Kathleen Picotte Newman, arguing that the attorney misrepresented the facts since it was her firm, Larkin, Hoffman, Daly & Lindgren, that negotiated the business sale. Though the case has yet to be determined, it is generally believed that Sax is unlikely to succeed in her lawsuit since she elected not to investigate the facts.

For that reason, business valuations are cost effective and even essential as part of divorce proceedings. Cutting corners to save on the cost of an appraisel may wind up costing you a significant amount more. Appraisers generally produce written reports which detail the analysis and steps taken to reach a value conclusion. Even in mediated divorces, appraisals are important. The parties may select a joint appraiser which helps reduce the costs associated with the appraisal for both parties.

The Institute of Business Appraisers (IBA) and the American Society of Appraisers (ASA) have also issued standards for valuing businesses. Although each business appraisal may require an appriser to make certain assumptions about the business or industry, each appraiser follows a similar general procedure applying professionally accepted standards. This has decreased the variability valuations. In short, if two appraisers review the same business, they may arrive at different values, but the gap between their appraisals should be fairly narrow. As a result, a professional appraisal would eliminate the inequitable result that Ms. Sax encountered in her divorce.

Regardless of the size of the business, it is critically important that you retain an attorney experienced in complex property issues. An experienced attorney will work closely with the qualified appraiser to arrive at a fair valuation of the business and provide advice on the legal consequences.