dividing a business in divorce

Divorce closes one chapter in your life and opens another. In order to move forward, you need a financial foundation. That foundation comes, in part, from your share of the marital assets. Minnesota is an equitable distribution state, in which marital assets are divided in a way that is fair under all the circumstances. When those assets include a small business, division of marital property can become complicated, especially if the spouses disagree about how to value a property in divorce. Let’s talk about how to value a small business in the context of divorce.

Whether a small business is marital or non-marital property, owned by one spouse or both, it is important to have a clear understanding of what it is worth. Minnesota courts typically only divide marital property—property acquired by either spouse during the marriage, with limited exceptions. However, even if one party is able to establish that a small business is their wholly non-marital property, its value could have an impact on the overall division of marital property.

Unfortunately, figuring out what a business is worth is much more complicated than determining the value of a bank account or car. Often, a business valuation expert such as a Certified Business Appraiser (CBA) or an Accredited Senior Appraiser (ASA) will need to be involved. The services of such an expert can be costly—but not nearly as costly as failing to use an expert.

Why an Accurate Business Valuation is Essential in Divorce

When faced with the prospect of paying an appraiser, some couples decide that it would be more cost-effective to agree on the value of the business and skip paying the appraiser’s fees. This cost-cutting approach is almost always short-sighted.

A 1997 Hennepin County divorce case illustrates why. In that case, Debra Sax and Paul Taunton divorced. Taunton owned a business called Athletic Fitters, Inc. (AFI) During the divorce proceedings, Taunton represented his annual income as $250,000, and the value of the business as $6 million; he had made similar representations during the marriage. Sax relied on Taunton’s representations in agreeing to settle the divorce.

Four months after the divorce, the business sold for $30 million. In the wake of the sale, an investigation revealed that in the years leading up to the divorce, Taunton’s income had ranged from $900,000 to $4 million annually. Sax sued to set aside the divorce decree for fraud, eventually settling with Taunton for an undisclosed amount.

However, it should be noted that setting aside a divorce property settlement in Minnesota is very difficult to do. Even when successful, the process is time-consuming and expensive. It is far better to get an accurate valuation of the business before attempting to reach a settlement in divorce.

Valuation Methods for Business in Divorce

How do appraisers begin to decide what a small business is worth? There are three basic valuation methods for a business: the income approach, the market approach, and the asset approach. The income approach is the most commonly used in divorce, and most accurate, though it is also generally the most complicated.

The income approach determines the current value of a business based on its anticipated future profits, cash flow or both. For businesses that are expected to have relatively stable earnings going forward, valuators may use the capitalization method, which involves calculating the value of expected future profits using a formula that takes into account current earnings and expected future performance. For businesses with less predictable earnings, the “discounting of cash flow” method is often used. Essentially, the valuator takes into account the company’s past performance, factoring in “discounts” based on investor risks.

The market approach looks at what a business might sell for on the open market with a willing buyer and willing seller. The approach is similar to a real estate agent determining how to price a house by looking at comparable sales of similar homes in the same area. The success of this method depends, of course, on whether there are similar enough businesses that have recently sold to provide a comparison.

The asset approach is probably the simplest of the three valuation methods—though it is far from simple. In essence, this method takes the value of the business’s assets and subtracts its liabilities to arrive at a value for the business. Assets include tangible assets like inventory and intangible assets like accounts receivable. This method is generally less favored than the income approach or the market approach in the divorce context.

A thorough discussion of these business valuation methods is beyond the scope of a brief blog post. What is important to take away from this post is:

  • A business interest is often among the most valuable assets divided in a divorce. Its value is too important to guess at—or to take a spouse’s word about.
  • A business valuation expert’s fees should be viewed not as a cost, but as an investment in reaching a fair divorce settlement (or judgment, should a trial become necessary).
  • It is essential to work with a divorce attorney who has extensive experience representing small business owners or their spouses in divorce.

If you own a small business or have an interest in a family business, or you are married to a business owner, you need to act as early as possible to protect your rights in divorce. If you have questions about business interests and divorce in Minnesota, please contact Mundahl Law to schedule a consultation.