As divorce lawyers practicing in Charleston, Dorchester, and Berkeley counties, we often have cases where one of the spouses owns a business or is otherwise self-employed. Generally, businesses or ownership interests are subject to division in the family court, just as any other piece of real or personal property, or financial accounts. First, it must be determined whether the business is a marital asset. A general discussion on determining whether an asset is marital or non-marital in South Carolina can be found here.
Determining the Value of a Business in a Divorce
Assuming that the business is martial property, the family court must then determine the fair market value of the company. The family court will consider the net asset value, the fair market value for its stock, and its earnings or investment value. In some cases, the parties can agree on the value. In other cases, at least one party will have to prove the value. If the case justifies it, a spouse can order a complete forensic appraisal of the business, but these valuations can be very expensive. In other cases, an opinion from a certified public accountant might be enough.
There are numerous methods than can be used by these professionals, but they generally fall under one of three categories: the asset approach, the income approach, or the market approach:
Asset Approach – The asset approach views the business as a set of assets and liabilities. In this approach, the value of the assets and and the liabilities are calculated, and the difference between the two is the value of the business. The challenge in this approach is determining what assets and liabilities to include, choosing a standard of measuring their value, and what each asset and liability is worth.
Market Approach – Simply stated, valuing a business according to the market is approach is determining what buyers would be willing to pay and the sellers would be willing to accept for the sale of a similar business. This approach requires market data and analysis to compare the purchase and sale of other businesses similar to the one in issue.
Income Approach – In this approach, a calculation is made as to the economic benefits the business will provide in the future. This calculation assumes that because the money hasn’t been earned yet, there’s some risk of not receiving all or part of what is expected. To establish the present value of the future income, and to factor in risk, the income approach requires different methods of analysis such as capitalization of expected earnings by a capitalization rate or discounting the cash flow of the business. Although a discussion of capitalization and discounting are beyond the scope of this article, the point is that regardless of the approach used, valuing the worth of a business is complicated, and it usually requires the assistance of a business valuation expert or certified public accountant.
Goodwill of the Business
Goodwill is generally included in the fair market value, as long as it attaches to the business itself, separate and apart from the individual owners. So, professional goodwill is usually not included. For example, if one spouse is a doctor, the patients generally follow the doctor, not the business, and the doctor’s practice might not be subject to equitable division in family court. Instead, the court may consider the value of the business when determining alimony. Click here for a general discussion on alimony in South Carolina.
Transmutation of a Non-Marital Business Asset
A business that was started before the marriage can become marital property under what is called the doctrine of “transmutation.” The family court decides whether property is transmuted on a case-by-case basis. By way of example, in one case, the South Carolina Court of Appeals agreed with the family court judge that a non-marital business became marital when the husband business owner listed the wife as secretary for the corporation. The wife had also reduced the hours she worked at her normal job so that she could work full-time in the business, reducing her contributions to her 401(k) accounts. Finally, the spouses agreed that the business would pay wife a higher salary for her services than would normally be expected in her position in order to benefit both parties and build their retirement together.
Equitable Division of the Business
If the company is marital property, the court must then decide whether to divide it 50-50 or in some other proportion. Working for a business or contributing financially to a business can strengthen a spouse’s claim in the business, but this is not necessary. For example, it is possible that a spouse who did not work at all but instead cared for the children and served as a homemaker could receive a 50% share in the value of a business. There is no bright-line rule, and every case is determined on a case by case basis. In many cases, it is not practical for the court to “split” the business between the parties. In these cases, the court will allow the title owner of the business to keep it but require that he or she buy the other person out. The buy-out could be in a lump sum, or the owner spouse could be required to make payments over time.
Hurdles in a Business Asset Divorce Case
All in all, divorce cases that involve a self-employed spouse can be tougher to resolve than other cases. First, there is the gray area as to whether the business is even a marital asset. Second, in most cases, the husband and wife could each hire their own CPA or appraiser to value the business, and the two values will likely not be the same. In fact, the two professionals may not even agree on the proper method for valuing a particular business. Ultimately, if the spouses can’t agree, the judge will have to decide what the value is. Finally, it is often more difficult to determine the income of a self-employed spouse because they have the ability to hide income in various ways. For a discussion on determining whether your spouse is hiding income or assets, click here.