Business Valuation in Divorce

How is a Business Valuated Differently from a House or a Stock Portfolio?

As part of a couple’s divorce proceeding, marital property is divided between the spouses. When spouses own significant assets, including homes, investment properties, businesses, retirement accounts, stock portfolios, professional practices, etc., the division of those assets can be quite challenging, even in the most amicable divorces.

Deciding who should get what in a divorce can be difficult, especially since the value of the assets to be divided between spouses is determined not only based upon the assets’ current market value, but also upon factors such as liquidity, cost basis, potential for appreciation, and tax implications associated with the sale of an asset, all of which can play a role in determining how each asset is distributed between spouses.

Therefore, it is crucial that thorough valuations are conducted by professionals experienced in valuing each specific type of asset, as not all assets are valuated using the same procedures. For instance, a business is valuated by a different methodology than real estate or a stock portfolio.

Different Methods of Valuation

There is a key difference between the process of the valuation of a business and the valuation of assets like real estate property. While real estate is normally valued through a comparison of the sale prices of other similarly situated properties, it is difficult to compare one business’s value with another’s.

Similarly, a stock portfolio can be easily valued by referral to the current price per share on the trading market, and the value is determined by supply and demand. The more people that want to buy a certain stock, the more the value goes up, and vice versa.

While it is possible to experience a sudden demand for a particular type of business, causing a rise in the business valuation, this is not the only factor that is considered when determining the value of a business.

Difficulty Accessing Comparable Financial Data

While stock price information is easily accessible, and a real estate agent can tell you the value of a home based on a comparable market analysis, for one small business to be valued based on comparable data to that of a similar business, it would require free access to the data of similar companies. This would only be possible in a situation where the similarly situated company is publicly traded.

However, when a company is privately held, accessing that company’s financial data is not as easy as asking for it nicely, especially since the company may see the spouse’s business that needs to be evaluated, as a competitor. Yet even though it is difficult to value a business without financial data from a comparable business, a business broker can analyze the necessary data to determine a business’s value and can apply market trends and critical success factors specific to the spouse’s business that can impact valuation.

Selling a Business Is Different From Selling Stocks or Real Estate

Valuing and selling a business is not as straightforward as selling a home or stock. First, there is the available pool of buyers. When you sell a business, the pool of potential buyers is usually reduced to people who are already operating in that industry or who have significant knowledge about the industry, since it would require a specific skillset to operate it. The time involved in selling a business, including the due diligence period, is substantially longer and much more complicated than what is needed to valuate a stock or a real estate property.

In addition, the liquidity of stocks and ability to sell real estate, versus the nature of a privately owned business, plays an important role in determining the value of each. For instance, a stock is typically sold at the listing price, and a home is normally sold fairly close to the asking price. However, the sale price of a business can be drastically reduced in value due to factors such as perceived earnings, information discovered during the due diligence period, or projections as to the business’s value in the future. Because of this, many businesses are not sold, so the value of the company is directly tied to its being managed by the spouse who operates it at the time of the divorce.

Adjustments to a Business’s Financial Statements

Unlike stocks and real estate, the process of valuation of a business sometimes requires an adjustment of its financial statements. A common practice for many business owners to reduce their tax liabilities is to minimize their annual profits by increasing expenses, which is a practice that can greatly affect the value of a business.

Time Doesn’t Necessarily Increase a Business’s Value

If a spouse has maintained his or her business for a long period of time, it is usually seen as a good indication that the business can withstand a decline or incline in the economy. Unlike the value of real estate, which historically increases in value each year, a business’s financial performance over time may not be as straightforward and can greatly increase or decrease year by year depending on market conditions.

If you are in a position where you must valuate your assets, it is important to understand the distinctions in the valuation of different types of assets and to seek the advice of a professional in the respective sector to determine each asset’s value.