By Adam T. Kronfeld of Duff & Kronfeld, P.C. posted in Family Law on Friday, January 18, 2019.
These days, especially in Northern Virginia, it is not uncommon for a divorcing spouse to own a substantial interest in a business, either one that he works for or one that is purely an investment. In either circumstance, the business interest can be classified as marital, separate, or hybrid property, just like any other asset. And, just like any other asset, even if the business’s ownership is solely in one spouse’s name, the other spouse may possess an equitable interest that may be awarded by a court in equitable distribution. Given the growing prevalence of this issue in divorce matters, you should have little trouble finding a qualified attorney who has significant experience in dealing with the equitable distribution of business interests. The explanation below is offered as primer to help you understand the business valuation process, and the respective roles that you, your attorney and the court play in that process.
Business interests come in a variety of forms.
A person may form a business – a corporation, limited liability company, or partnership, among others – for any number of reasons. A business’s operation could be as complex as a one hundred member law firm or as simple as one person renting out an apartment. The business could be owned by a single individual or by dozens of individuals.
Where the business interest is owned in the sole name of your spouse, and assuming that it is marital property, then the only way the court can give you a share of that business interest is by way of a monetary award. The court cannot make your spouse give you individual shares in the business or individual assets owned by the business. Instead, the court may only order your spouse to pay you an amount of money that the court believes is appropriate, under all of the circumstances of the case, to compensate you for your equitable interest in the business asset. The asset that is subject to equitable distribution by the court is your spouse’s ownership interest, not the various assets that the business may itself own. For example, if your spouse has formed a corporation that owns and rents out townhomes themselves cannot be transferred to you or ordered to be sold, but you can be given a share of fair value.
Before the court can give you a monetary award to compensate you, the court must be presented with evidence sufficient to allow it to place a value on your spouse’s interest in the business asset. However, the fact that your spouse owns a business does not necessarily mean that he owns a business that has any value. This is particularly true if your spouse is the sole employee of his business and performs most or all of the work himself. A common example would be a handyman or consultant who is the sole employee of a corporation that he established and owns and who earns a modest salary. In some circumstances, these sorts of businesses may have little or no value.
The specific evidence that is sufficient for the court to give the business a value may vary wildly from case to case.
For example, if your spouse owns a corporation that in turn owns a house that it rents, it could be sufficient to simply have a property appraiser present an opinion as to the value of the rental property. When you are faced with a larger business that has revenue that fluctuates from month to month and year to year, and possibly equipment, inventory, loans and debts, multiple owners or partners – such as a law firm, car dealership, or automotive repair shop – the court will almost certainly need guidance from an expert in the business valuation of business interests. Such experts are typically CPAs who have received further specialized education and training in how to determine how much a business interest is worth to an individual who owns it.
The larger and more complex the business is, the more information a business valuation expert will need in order to value it.
It will be necessary for the expert to review financial documentation concerning the business’s assets, debts, revenue and expenses. The expert may have to analyze complex financial reports, tax returns, bank statements, profit and loss statements, asset appraisals, operating agreements between co-owners, and various other documents that relate to the businesses operations and finances. For very complex businesses, this can mean that your attorney must procure from your spouse or the business itself hundreds or thousands of documents, which can be a costly and laborious endeavor. Your attorney will have to issue discovery requests, likely to include subpoenas for records, and may need to conduct the deposition of your spouse and/or someone from the business who can answer factual questions about the businesses operations and the documents procured.
The business valuation is one part of the litigation process in which your direct involvement will most likely not be necessary. Assuming that you have given your attorney the information sufficient for him to understand that there is a business valuation issue that needs to be pursued, it is your attorney’s responsibility to take the lead in identifying and recommending a qualified expert to perform the business valuation and to provide the expert with the information necessary to do so. You and your attorney can certainly agree to delegate some of that responsibility to you, or some other individual, but your attorney is ultimately responsible.
However, it is important to understand that your attorney is not financially responsible to pay the expert or other litigation costs. Consequently, the time will likely come when your attorney will tell you that he needs money sufficient to retain the expert and pay the expert for his time in performing the business valuation, as well as the expert’s time preparing for and appearing at trial. The cost of a business valuation is not trivial; the expert’s analysis alone can cost thousands of dollars, not including the attorney fees and out-of-pocket costs involved in obtaining the relevant documentation, educating the attorney such that he or she understands the nuances of the particular business, preparing the expert for trial, and actually presenting the expert testimony at trial.
In view of the cost, it is important that you and your attorney discuss early on whether there is a need and benefit to obtaining a business valuation.
As noted above, small and/or simple businesses may have little or no value and the cost of proving that “little or no value” could easily exceed any money that you may be awarded by the court. However, where there is a business that is substantial in size and potential value, the cost for a business valuation could pay for itself many times over.