Valuing a Family Business in a Divorce

By August 6, 2020 Business

There are several legal ramifications to a divorce (or, the legal term in Arizona, a dissolution of a marriage). Not only does it legally dissolve a marriage, it also determines important things like child support, legal decision-making authority (custody) and parenting time (visitation), spousal maintenance (historically called alimony), and division of assets and debts. In the state of Arizona, all property acquired during the marriage is considered “community property” (with a few exceptions), which means it will be split by the parties in the event of a divorce. This split is called an “equitable distribution”, which usually means the property will be divided equally, absent some compelling reason why it should not be.

The exceptions to community property — anything the parties acquired before the marriage, or during the marriage as a result of a gift or a bequest from a will (inheritance) is considered separate property, which the party gets to keep. Often disputes and discussion arise as to what equitable distribution of community property looks like. In many divorces, the community property is comprised of assets (and liabilities) that are fairly easy to divide – things like homes, bank accounts, cars, personal property, and credit card debt. However, for people who are entrepreneurs or own their own businesses, valuing this asset and dividing it equitably can be difficult and create conflict.

It may be necessary to hire an expert to do a valuation of the business involved in a divorce. Even once the expert is retained, a question arises as to what formula or methodology should he or she use? Most businesses have similar tangible assets that the marriage does, like bank accounts and physical property (such as, equipment or inventory). However, it also have intangible assets that can be difficult to quantify, things like name recognition and goodwill. For example, say Mr. and Mrs. Smith own a cleaning service called “Smiths’ Cleaners, LLC.” If Mr. Smith is no longer affiliated with the business, what does that do to its value?  Or in a different scenario, if Dr. Smith owns her own professional practice, but she began the practice during her marriage to Mr. Smith, using the degree she earned while Mr. Smith supported her, and both have benefited from its success, how is its value determined and what is an equitable distribution to Mr. Smith?

Courts in Arizona have broad latitude in the way they determine the dollar value of a business for purposes of dividing community property. According to the 1996 Arizona Court of Appeals case Kelsey vs. Kelsey, “the valuation of assets is a factual determination that must be based on the facts and circumstances of each case. The trial court has discretion to rely on various methods of value in the professional practice and to qualify expert witnesses who testify regarding asset valuation.”

However, the valuation has to be based on something. Two common valuations used by experts in divorce cases are fair market value and fair value. Fair market value (“FMV”) is defined as “[T]he price at which the property would change hands between a willing buyer and a willing seller when the former is not under any compulsion to buy and the latter is not under any compulsion to sell, both parties having reasonable knowledge of relevant facts.”  Essentially, FMV is based on how much the business would be worth if it was sold on an open market, which means that it can include discounts for marketability of the business or if the person whose interest is being valued owns a minority stake in the business. Fair value, on the other hand, does not include any discounts. These two estimates of businesses can be substantially different, and each party will try to convince the court to adopt whichever valuation he or she thinks will be most advantageous to his or her position.  For example, the person retaining the business will usually desire a lower value so that the payment to the other party is smaller (and vice versa).

Ultimately, the trial court is required to make a decision or factual determination, which results in “substantial equality,” but there is no standard that is applied uniformly. A trial court has broad discretion in determining what is the value of the business, what date the business should be valued as of, and what is an equitable division and distribution to the other party for his or her share.  Indeed, the court could order the business sold and the proceeds resulting from the sale divided equally.

Navigating the court system can be confusing and intimidating, especially in valuation matters and division of assets, as explained above.  At Provident Law® our vision is to “bring peace to our clients through excellent legal representation.”  If you or someone you know has questions regarding adoptions or any other family law matter, contact us today to schedule a consultation with Anne Munsil Courchaine or Jim Mueller.  Our family law attorneys provide legal representation in all family law matters, including guardianships, separation of marriage or divorce proceedings, prenuptial and postnuptial agreements, child support modifications, spousal maintenance, emancipation, and domestic violence and order of protection issues.

Anne Courchaine is an associate attorney with Provident Law®, where she focuses on real estate, commercial litigation, and family law. She can be reached at a.courchaine@providentlawyers.com or 480-388-3343.