It is an unfortunate American reality that half of all first marriages and almost 60% of second marriages end in divorce. When business partners divorce, the financial and emotional challenges become more complex. In addition to negotiating the separation agreement, dividing marital assets, assessing liabilities, and determining child support arrangements, they must address the myriad of issues involved in valuing their business and planning for succession.

Faced with the possibility of divorce, it is up to every family business to establish a comprehensive divorce strategy, clearly indicating how the business will be affected if the parties separate.

Some important considerations for married business partners include:

Sell ​​or keep the business

A business is often the single largest asset of any couple, and a divorce may require that the business be sold and the proceeds divided between the parties. Before it can be sold or exchanged for other marital property, a business valuation must be prepared. Once both parties understand and agree on the value of the business, the decision to buy a part, divide the business, or sell to a third party should be clearer.

Business Valuation

To determine the value of any business, a professional appraisal expert should be hired, whose role is to help the parties determine the fair market value of their business. In divorce cases, it is imperative that the appraiser be impartial and independent of both parties. A divorcing couple should have a neutral third party attached to the valuation appraiser, avoiding a lengthy and costly “valuation war” in which parties attack the other’s methodologies and opinions, which may require taking the average of both valuations.

To determine the fair market value of the business, an appraiser seeks information from many sources using a combination of three types of valuation methodologies:

• Income approach
• Asset approach
• Market focus

Generally, an ‘Income Approach’ determines value by calculating the net present value of the business’s profit stream (discounted cash flow), while an ‘Asset Approach’ determines value by adding the sum of the parts of the business (value of net assets). Finally, a market approach determines value by comparing the company in question to other companies in the same industry/of the same size/within the same region.

The valuation is the appraiser’s educated opinion based on the results of their approach. An appraiser must not only be technically proficient, but also willing to educate the parties to ensure that they both understand the final number and know how it was obtained.

When choosing a business appraiser, business owners should hire an experienced expert who specializes in businesses of their size (i.e., market capitalization, number of employees), their industry, or even the purpose of the appraisal (divorce, buy and sell). A Bernier vs. A Bernier divorce is difficult enough, but negotiating the disposition of a jointly owned business can present unexpected complexities.

In the landmark 2007 Massachusetts Supreme Court case of Bernier vs. Bernier, bereavement experts squabbled over assessment methodologies and the court was left to decide. In this case, the husband’s expert treated the couple’s S corporations as if they were C corporations, applying an “average tax rate” of 35% to the earnings, resulting in a valuation of $7.85 million. The wife’s expert declined to apply the C Corporation rates and arrived at a valuation of $16.4 million. The trial judge, citing prior case law and an old IRS manual, adopted the “tax affected” value of the husband’s expert. But the reliance on the training manual was “misguided” according to the Massachusetts Supreme Court, and the earlier case’s application was incorrect.

After reviewing case law and literature, he “generally adopted” a valuation metric from an entirely different state (Delaware). This arbitrary valuation can occur when the parties cannot agree and the Court determines that both appraisers have not presented valuations using discernible facts.

estate planning

Overall, about 30% of family businesses successfully transition from the first generation to the second, and only 12% transition to the third. While the reasons for these low rates are numerous, the result is that many businesses are sold, divided among the family, or discontinued altogether.

In the event of divorce, the succession rate is even lower, with only 10% of spouses continuing to operate the family business together after divorce. If you are thinking of starting a family business, or already have one, it would be wise to create a comprehensive divorce strategy. As difficult as a conversation is, it will be much easier now than the three of us separated.