The family business

Another major asset that can cause serious complications in a divorce is the family business. Now, we aren’t talking about owning some stock in a huge publicly traded corporation. This is the small business, few shareholders (or partners), probably mostly family members. It may be a professional practice (medical, dental, accounting, attorney, real estate brokerage) or a retail outlet (restaurant or shop). This asset gets complicated because it isn’t just an asset, it is frequently also the family’s source of income. Each type of business has its own set of problems and complications, but there are basically three methods of handling the business during divorce:

1. Both parties continue to own the business. You both worked in the business while you were married. Maybe you have a better business relationship than personal. There are some people you can work with, but wouldn’t want to live with. However, if there is a great deal of anger, or otherwise bad blood in the divorce, working together is not the best option for either you or your business.

2. Sell the business and divide the profits. This is the partition by sale method. You know you don’t want to work with your ex ever again, so why not just sell the whole thing and start over on your own? Most businesses cannot be easily sold, however, and finding a buyer can take ages (especially in the current economy). Also remember, while you are trying to sell the business, one of you still has to run it. You may not be comfortable with the idea of your ex being in control of what is partially your property.

3. One spouse keeps the business and offsets a portion of its value with other assets. Basically, one spouse "buys out" the other. This is a partition in kind method, and is usually the best option, assuming that there are other assets to balance things out. The business benefits because it has continuity of ownership, and you and you ex benefit by not having to deal with each other.

So how does the buying spouse pay for the buy-out? Equity in the marital home is often used as an offset for the buyout, but this can be a problem if the other spouse needs cash flow. A home does not provide income and actually requires cash pay bills and maintain. IRAs or 401(k) plan assets are often used to offset the business, but there may be tax consequences for making withdrawals from these accounts. Securities (like stocks and bonds) and cash equivalents are often the most desirable in offsetting the value of the business. Little or no tax liability is associated with these and they can easily be converted into cash if the other spouse needs it.

The above discussion works off the assumption that both spouses are involved in the business, but what if only one spouse is involved? Is the business separate property, community property or both?

A business started during marriage will be community property in Texas, unless it can be proved (by clear and convincing evidence) that the business was started with separate property funds (tracing). A business that was already in operation or was begun with separate funds is more complex. Community property and/or money may have been used to expand the business and any appreciation attributed to that contribution. If both spouses played a role in running the business, the contribution of each spouse must be considered. Even if a business is proved to be the separate property of one spouse, the salary he/she draws from the business will be community. You will most definitely need an attorney or other expert to help you determine the character of your business as separate or community property.

The key elements to determine community property vs. separate property are:

• The source of funds for the startup of the business;
• The date of the marriage;
• The date of valuation (determining the value of the business) due to divorce;
• The contribution of each spouse to the business.

The date of the valuation can be either the date that you and your ex separated, the date one of you first filed for divorce, the date of your first hearing, or some other agreed upon date.

When a business is appraised, it is called "valuing" or "valuation." This is a very complex task, requiring the assistance of a professional business appraiser. The valuator must be skilled in identifying the relevant information and applying the appropriate valuation methods. The valuator must have a thorough understanding of the business. Your lawyer should be able to recommend a valuator for your business. Of course, the opposing side will likely prefer their own. If a professional valuator cannot be agreed upon, the court may appoint one either based on one side’s recommendation, or of its own choosing.

The valuator must select appropriate valuation methods. To make this selection he/she will look at factors such as the characteristics of your business and the availability of relevant information. All valuation methods fall within three categories or "valuation approaches". These are the market approach, the income approach, and the asset approach.

In the market approach, your valuator estimates your business’s value by comparing it to a similar business that has been sold recently. The income approach estimates the value of your business by converting your business’s profits or cash flows into value. The asset approach estimates the value of your business based on the values of the assets and liabilities of the business. This includes both tangible assets, like an office building, and intangible assets like "goodwill" (more about goodwill in a bit).

Most of the time, your valuator will use more than one approach in coming up with a value for the business, usually a combination of the market and income approaches. Appraising a business is not an exact science, and the valuator will want to get a more accurate picture of the value of the business, and more information on which to base his/her professional judgment. Note: the "book value" of a business, which is the assets minus the liabilities on the balance sheet, is not a valuation method used by professional business valuators.

Keep in mind, as with your lawyer, a professional business valuator will cost you. However, as with your lawyer, in the long run, it can be much more expensive not to have one. The price of having your business valuated largely depends on the size and complexity of the business itself and the level of appraisal services that the client selects. Business valuators frequently will have an "initial report" price to prepare a report to be used in settlement negotiations, a "full report" or hourly price for the more extensive work needed to be done for a full trial, and a fee to testify in court as an expert witness. Talking to a professional business valuator early on in the divorce process about the different options can save money.

We mentioned earlier that a value must be put on both the tangible assets of a business as well as the intangible ones such as "goodwill". What is a business’s "goodwill"? Goodwill value is essentially the total value of the business minus the total value of the company’s tangible assets. So you have to know what the value of the business itself and the value of its parts (assets) are first. Then figure out how much more the business is worth than simply the sum of its parts. In addition to this, Texas courts often require that the value of business goodwill be split into two types for divorce purposes: "personal goodwill" (sometimes called "professional goodwill") and "enterprise goodwill."

Personal/professional goodwill is the good will that is directly tied to you personally, the value that is added to the business because you are part of it. Allow me to brag for a minute. My father owns his own business, and he IS that business. Almost the entire value of his business is due to his personal skill and expertise. This is his "personal goodwill". Texas courts hold that this part of the business’ goodwill is not marital community property to be divided by the court. It goes with the individual person who generated it.

The "enterprise goodwill" is attached to the business itself, even if the individual were to leave the company. Maybe your business has been established in your area for a while and clients come in for the company name and reputation rather than yours specifically. Texas courts typically treat enterprise goodwill as community property that is subject to division between the spouses.

In order to save money when employing a valuator, be organized in advance. Organize your documents and provide a full set to your own lawyer and business valuator, as well as to those of your spouse. With your business valuator, as with your lawyer, you need to communicate fully and openly. This will enable him/her to do the job more effectively and efficiently.

How do you choose an expert business valuator? Finding a true expert may be difficult, but it will be worth doing your homework on the subject. Business valuation is a relatively new profession. You want to find someone with as much experience as possible and a good track record, preferably someone with experience as an expert witness as well. Your lawyer should be able to help you decide on an expert.

Look for appraisers who hold either the Certified Business Appraiser (CBA) or Accredited Senior Appraiser (ASA) credentials in business valuation. Earning either of these credentials requires the applicant to (i) pass a highly technical exam; and (ii) submit appraisal reports proving that they can perform appraisals competently. The process is rigorous and the pass rate is low. Look for a CBA or ASA appraiser at these organizations:

• Institute of Business Appraisers (IBA), http://go-iba.org
• American Society of Appraisers (ASA), http://www.appraisers.org/