When a divorcing couple owns a family business, it complicates the parties’ financial settlement. Generally, the business will be awarded to one of the spouses and how it is valued and divided depends on the type of business that is involved.
When One Spouse is a Licensed Professional and Owner of the Business
When one of the spouses is a licensed professional, like a doctor, attorney, Certified Public Accountant (CPA), for example, the business must be awarded to that licensed professional without whom there would be no business. The professional practice must be valued by a forensic accountant.
When the Business is a Family-Owned Business
When a business is a storefront retail business, either party can be awarded the business. It can be awarded to one party and the other one essentially sells his or her share to that spouse. It still needs to be valued by a forensic accountant so that the asset can be equally divided by offsetting its value against other community property assets.
In rare cases, the couple may decide that even though they cannot continue their marriage, they can still be good business partners and work well together. They may each keep a 50 percent ownership of the business and move forward dividing their other assets equally. In this situation, there is no need to place a value on the business.
How a Business is Valued
Businesses are valued based on income and, therefore, a forensic accountant looks at the income the business generates to the owner. This is determined by looking at tax returns, financial statements, general ledgers, and other financial documents. There are three major approaches used:
1) Excess earnings – IRS Revenue Ruling 68-609.
2) Capitalization of earnings – Pure income-based approach.
3) Market data approach – The accountant compares the business to the amount for which other similar sized businesses (ideally in the same geographical location) have been sold.
Advantages of a Collaborative Divorce or Mediation When Dividing a Business
Both the Collaborative Divorce process and Mediation have advantages over traditional litigation when it comes to dividing a business. They allow the spouses to be more creative in the way they formulate their settlement agreement.
For example, in a litigated divorce the court is required to make a division a certain way based only on the value of the business and spousal support guidelines. Because the business is valued based on income, the owner of the business can feel like they are paying twice.
In a Collaborative Divorce, the couple can customize an agreement. After obtaining the value of the business, they can discount that value when dividing up their assets, or make an adjustment by lowering the amount of support. This mitigates the economic double dip experienced in professional practice situations that the courts cannot legally avoid.
Developing options for dividing the marital estate is one of the benefits of Collaborative Divorce. The process involves a neutral financial professional who can assist the couple in making the best decision for how to divide the family business.