How to Value a Small Business in a Divorce Proceeding

When property division occurs in a divorce, and a business is involved, several terms can come into play. 

Book Value

This is defined as the difference between the purchase price of an asset and its depreciation over time and is the basis for business financial statements. 

There can be a vast difference between the book value of an asset and its value on the market. A plot of land purchased by a business 30 years ago for $9,000 may have a fair market value of 20 times that figure now. Your lawyer may refer to legal statutes to determine which of these applies in a divorce proceeding, or it may be decided upon by the court. Either way, it is important that all parties understand and consider the disparity that exists between these two standards.

Fair Value vs. Fair Market Value

There are basically two ways of approaching a business evaluation for divorce proceedings. In some jurisdictions, a company’s value is based on its worth to the owner (known as fair value); in others, its value is determined by what an individual other than the owner believes it is worth (known as fair market value). Great discrepancies may exist between these two different standards. 

When discussing fair value, the concept is greatly dependent on business conditions and may by quite subjective. For instance, the standards used to determine fair value in stockholder disputes may not be the same ones applied during divorce, and the standards used in divorce may be different from state to state as well as different within the state as counties and even judges differ in their interpretation. Although various definitions of fair market value exist, usually it is regarded as the amount a willing buyer will pay to a willing seller for his or her business. Problems also arise when judges and some experts incorrectly use the term fair market value for fair value.

Taking action in the following ways will help parties reach agreement:

• Allowing both parties to review the company records and books
• Referring to a professional for adjustment
• Allowing both parties to determine the company income


Reliability of Business Financial Statements

Whether or not a lawyer considers a business financial report reliable has a great deal to do with who generated the report and whether the preparer is independent or not. These reports may be created by a certified public accountant who works under contract or by an accounting specialist or bookkeeper who works for the company directly.

Least Reliable

A business financial statement internally created by an employee of the business probably holds the least credibility. The qualifications of the person generating the report may have some deficiency, or in some cases, the report may be slanted toward the best interests of the business.

Preferable

A statement assembled and presented by a certified public accountant (CPA) is typically viewed as more reliable that one prepared by an internal employee of the business. The CPA will watch for inconsistencies or questionable entries or transactions but is not required to make any other assessment of the data provided.

More Preferable

Next in line in order of credibility are business financial statements that have been examined (reviewed statements) by the CPA for consistency, soundness and reliability. The best of all of these is a reviewed statement in which the transactions that comprise it have also been examined.

The Bottom Line

Regardless of who prepared the financial statements for the business or how they were generated, they are still based on the book value. Because of the disparity between book value and fair market as a tool for marital estate valuation in a divorce, the business financial statement may not be the best choice.