Divorcing a Business Owner: What His Company Is Really Worth

Who commissioned it, and which approach

The first question about any business valuation in a divorce is who hired the appraiser. An appraiser can be independent, meaning not an employee of either side, without being neutral. In many divorces the report was commissioned by one spouse, and it reflects the questions that spouse asked.

The second question is the approach. A business can be valued on what it earns, on what similar businesses have sold for, or on what it owns. For a service business or professional practice, where the value lies in earnings rather than equipment, valuing it on what it owns produces a low figure almost by definition.

The year before filing

A valuation is supposed to normalize the financials, adjusting for items a stranger buying the business would not pay for. Three matter most.

The owner’s salary. If he pays himself well above market, reported profit looks small. A proper valuation adjusts pay back to what it would cost to hire someone to do the job.

Personal expenses run through the company: the vehicle, the travel, a family member on the payroll. Each reduces reported profit and each should be added back.

Timing. Revenue that slowed, billing that was delayed, or a contract that closed only after the valuation date. None of this requires fraud. It requires an owner who saw the divorce coming, and the twelve months before filing deserve a close look for exactly that reason.

Goodwill is the biggest lever

Goodwill is the value of a business beyond its equipment and receivables, and it is usually the largest single lever in the report.

It divides into two kinds. Enterprise goodwill belongs to the business: its name, its systems, the clients who would stay if the owner left. Personal goodwill belongs to the owner: his relationships, reputation and skill. In many states personal goodwill is not a marital asset.

The consequence is direct. The more value is characterized as personal, the smaller the marital asset becomes. That split is argued rather than calculated, and it varies by state.

What the valuation leaves out: the tax

A valuation states what a business is worth. It does not state what it is worth to the spouse receiving it.

An interest that moves between spouses in a divorce is generally not taxed at the time, but its original cost moves with it, so the gain built up over the marriage becomes the recipient’s to pay when it is eventually sold.

A minority interest has further problems. It has no ready market, may pay nothing, and in an S corporation or partnership can generate a tax bill on profits the recipient never received. Tiffani Lindstrom, CPA, CVA evaluates a business interest on that after-tax basis, alongside the valuation itself, because an equal split on paper can be substantially unequal in practice.

The double-dip argument

One argument appears in many divorces involving a business, and it is worth recognizing before it is used. It holds that the same stream of income cannot be counted twice: once to set the value of the business, and again to set alimony. Whether and how that argument applies varies by state, and it can reduce either the business value or the support figure. Its practical effect is that the valuation and the support negotiation are connected, even when they are handled as separate conversations. A settlement that looks favorable on the business may have given something up on support, or the reverse, and the two are best reviewed together.

What to ask for

Ask for the full valuation report and the documents behind it, not the summary. Ask which approach was used and why, which valuation date applied, how the owner’s compensation was adjusted, and how goodwill was split. If the number is large enough to matter, it is large enough to have reviewed by someone working for you.

This page explains how divorce valuations work. It is not an opinion on the value of any business.