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Rombro & Manley LLP

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What is the purpose of business valuation in divorce?

On Behalf of | Oct 29, 2021 | Divorce

California business owners prioritize the needs of their enterprise to ensure its success and to protect its value. In a marriage, the business is arguably the largest asset in the household, so a divorce proceeding can put it at serious risk depending on the protections the owner has put in place to circumvent future complications.

California is a community property state, where the court views assets or debt that either spouse acquired during the marriage as subject to equal division. The circumstances of one spouse may change that determination, but for a family business it may mean evaluating it to be split along with all other assets. Residents of Manhattan Beach may want to find out more about steps they can take that will avoid this scenario to protect their business.

Which approach to business valuation is best?

 When evaluating a business, it is important to consider its organizational structure as well as the means of evaluating it. There are in general three approaches that prioritize different aspects of the overall profitability of the entity:

  • The asset approach has a simple formula that calculates assets against liabilities. There are complications to the method, however, when it comes to evaluating items such as a company car, computers, office equipment or inventory.
  • The market approach, which is least often used, makes the valuation based on the sale value of other businesses of a similar size that were recently on the market. If the family business has a unique niche, it may be impossible to find another business that is similar.
  • The income approach, which is the method most often used in divorce litigation, looks at revenue as well as past performance and future growth projections by examining cash flow and profits. Income is the total value of the proceeds from goods and services sold, including investment-related proceeds.

Are there other factors that influence valuation?

The business structure of the entity can expose it to risk in a divorce. A sole proprietorship, for example, will most probably be subject to division in a divorce unless the owner created a pre- or postnuptial agreement that defines the relationship of the business to the marriage and the allocation of its appreciation and income.

State laws govern the valuation of a limited liability company when it comes to property valuation, and for a corporation in which there are shareholders who receive dividends, these assets become part of the overall business valuation.

The choice of valuation for the business as well as other concerns, such as the completion of the valuation as close to the divorce proceeding as possible, will be factors that can affect the outcome of the proceeding.