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A.J. Grossman: What is a business valuation, and why is it necessary?

Hi, everyone! I’m A.J. Grossman, CEO and Managing Attorney with Leap Frog Divorce. My entire legal career has been dedicated to helping people with divorce and paternity cases. At Leap Frog Divorce, we do divorce better. Let’s get started!

What Is a Business Valuation?

Closely held businesses, meaning businesses that aren’t publicly traded on the stock market, can be important assets to address during a divorce. These may include family businesses, sole proprietorships, limited liability companies (LLCs), and corporations.

Businesses come in many forms, including hair salons, dog grooming businesses, merchant services companies, lawn care services, roofing and construction companies, and accounting firms.

When a business is involved in a divorce, several important questions may arise:

• Who will keep the business?
• How will the business be valued?
• Does the business’s value include goodwill?

Let’s look at each of these issues.

Who Gets the Business in a Divorce?

Courts generally seek to avoid arrangements that would force divorcing spouses to continue operating a business together. Depending on the circumstances, one spouse may retain the business while the other receives assets or compensation to account for their share of its marital value.

The spouse who primarily operated the business during the marriage may be a practical candidate to continue running it. Professional businesses, such as law firms and medical practices, can involve additional considerations, including licensing and professional qualifications.

The situation can become more complicated when the business has owners outside the marriage. In those cases, the court may need to consider the interests of other owners and how different arrangements could affect the company’s continued operation.

The appropriate outcome depends on the business, its ownership structure, and the circumstances of the divorce.

How Is a Business Valued?

Business valuation experts generally use three primary approaches to estimate a business’s value: the asset approach, the market approach, and the income approach.

1. The Asset Approach

The asset approach estimates a business’s value by considering its assets and subtracting its liabilities, with adjustments made as appropriate for the valuation method being used.

Assets may include tangible items such as:

• Inventory
• Computers and office equipment
• Company vehicles
• Machinery and other equipment
• Commercial property

Businesses may also have intangible assets, such as patents, copyrights, and trademarks. Accounts receivable may also be relevant to the valuation.

This approach considers the business’s assets and obligations to help determine its value.

2. The Market Approach

The market approach estimates a business’s value by comparing it with similar businesses that have been sold.

This is similar to how a real estate professional may look at comparable home sales to help estimate a property’s market value.

However, the market approach can be more challenging when a business is unique or when reliable information about comparable sales isn’t available.

3. The Income Approach

The income approach estimates a business’s value based on its ability to generate future income or cash flow. The valuation expert examines financial information and other relevant factors to estimate the business’s future economic performance.

This approach can be especially useful when comparable business sales are limited. It requires careful analysis of the company’s financial history, expected performance, and the risks associated with future earnings.

A business valuation expert can determine which approach or combination of approaches is most appropriate for the business being evaluated.

What Is Goodwill, and Why Does It Matter?

Goodwill is another important consideration in business valuation. In general, it refers to value associated with factors beyond a business’s identifiable assets and liabilities, such as reputation, customer relationships, and the ability to generate continued business.

In divorce cases, it’s important to distinguish between personal goodwill and enterprise goodwill.

Personal Goodwill

Personal goodwill is associated with an individual’s skills, reputation, relationships, and continued involvement in a business.

This may be particularly relevant to professional practices, such as law firms and medical practices, where clients or patients may rely heavily on a particular professional’s expertise and reputation.

Because personal goodwill is tied to the individual rather than the business itself, it may be treated differently from enterprise goodwill when determining the value subject to equitable distribution under Florida law.

Enterprise Goodwill

Enterprise goodwill is associated with the business itself and can continue to exist even when ownership or management changes.

For example, consider a local car dealership with an established reputation, loyal customers, and strong business relationships. Customers may continue to visit the dealership even if the person running it changes.

That value is associated with the business as an enterprise rather than solely with one individual’s personal reputation.

The distinction between personal and enterprise goodwill can significantly affect a business valuation during divorce. Determining whether goodwill exists, what type it is, and how it should be valued requires careful consideration of the business and applicable law.

Why Business Valuation Matters in Divorce

When a business is part of a divorce, determining its value can help the parties and the court address how marital assets and liabilities should be distributed.

A qualified business valuation expert can help evaluate the company’s financial position, apply appropriate valuation methods, and analyze relevant factors such as goodwill.

Every business is different, and the valuation process can be complex. Understanding how it works can help you prepare for the financial decisions involved in your divorce.

That’s all for now. I hope you found this information helpful. If you have questions about business valuation and divorce, feel free to reach out to me. Give me a call or send me an email.

Have a wonderful day!