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The Basics of Business Valuation

In some cases, the community estate – in other words, all the marital assets – includes a business. In general, an equal division of the business must be predicated on fair market value. But determining what the fair market value of a business can be complicated.

Sometimes when a community estate includes a business, people going through divorce might decide to have the business valued by a forensic accountant, or by a professional appraiser knowledgeable about the particular type of business at issue. Each side can hire their own forensic accountant; or, you and the other party might decide to jointly retain a forensic accountant, in which case you can also decide either to be bound by the joint expert’s opinion, or to retain the right to bring in your own expert later on should that become advisable.

Valuation approaches differ based on the nature of the business or professional practice and the purpose for which the valuation is conducted. For example, the valuation of a small dry cleaning business might utilize a very different approach from that of a partnership interest in a large executive search firm. Especially with all the new types of businesses that have been created in recent years, for example in the technology field and the financial sector, you might wonder what your business is “really” worth.

“Book value”, “going concern value”, “discounted cash flow analysis”, “excess earning”, “goodwill”… these are all accounting terms you may have heard of which are used in connection with business valuation.

The following are some basic concepts used in determining a business’ worth. This information is by no means a complete exploration of these concepts, and you should discuss the matter with your attorney if you have questions.

“Asset valuation” focuses on the total assets a of a business, minus the liabilities. This type of valuation might be used where a business is going to be liquidated. “Book value” looks to the amounts paid for various assets and takes into account their depreciation. “Excess earnings valuation” or “capitalized earnings valuation” focuses on the earning power of the business to determine a rate of return.

“Goodwill” is an intangible component of the business’ value, and results from the owner’s skill, reputation, and the expectation of continued patronage by existing clients or customers. Goodwill is often the element of a valuation of a commercial business or a professional practice that is most susceptible to differing opinions.

It is important to realize that courts are not limited to any one valuation method. Two forensic accountants utilizing different business valuation approaches might arrive at very different values for a business. Each case is unique and which approach you use — whether you hire your own expert, retain a joint expert with the other side, agree to a value without using expert opinions, or some other approach — depends on the facts of your case.

Divorce and Retirement Accounts

An often asked question is: Now that I am getting divorced, what happens to my/our retirement accounts?

This can be a complicated issue, but generally speaking, pre-marriage and post-separation retirement benefits remain the property of the spouse who earned or acquired the benefits. Benefits earned or acquired during marriage, however, are community property, owned by the parties 50-50. Given that most people continue to make contributions to their preexisting retirement plans after they are married and after separation, most retirement accounts and pensions contain both separate and community property.

How does this all get sorted out? Sometimes it is a fairly straightforward matter, but more often an actuary is retained to calculate the separate vs. community property portion of retirement plans/accounts.

The assets in certain retirement plans (e.g. pension accounts or 401(k) accounts) are protected under Federal law, and a court order, approved by the retirement plan, is necessary. The assets in such accounts must be distributed according to a Qualified Domestic Relations Order (QDRO), which creates an alternate payee and assigns the alternate payee the right to receive plan benefits payable to the plan participant. IRA’s, on the other hand, are subject to state law and can be divided without a QDRO.

Each case is different, and the attorney in charge of your case will advise you on how to proceed.

Transmutation Issues

On October 7, 2006, Lana Norris gave a presentation at the annual meeting of the California State Bar in Monterey. The subject of the presentation was “transmutation.”

“Transmutation” means changing property from separate (owned solely by one spouse) to community (owned jointly by the spouses), or from community to separate, or from the separate property of one spouse to the separate property of the other spouse. This is an evolving area of the law, with many traps and pitfalls for people who are not aware of the latest appellate court decisions, and the latest interpretations of statutes dealing with this subject. As Ms. Norris explained in her presentation, in just the past year alone there have been significant developments in this area of the law, and a person’s signature on certain documents will transmute the property that is the subject of the document, whereas a signature on other documents will not. The document itself is controlling, not the intent of the person signing it, and a court must decide as a matter of law whether or not the words of the writing are sufficient to change ownership. Too often, people are unaware of the legal consequences of what they are signing.

Here are some examples:

…..If a person changes her money-market account statement into the names of herself and her husband as joint tenants, does that change the account into community property? (No)

…..If a person instructs his broker to “transfer” certain stock into his wife’s name, does that change the ownership? (No)

…..If a husband and wife want an IRA disbursement from a community (joint) IRA to become husband’s separate property and they sign a consent form so that the disbursement will go into his living trust, does signing this form accomplish their goal? (No)

…..Does a statement in a will saying that certain property is separate, or community, make it so? (No)

…..Is a deed signed by one spouse, transferring her interest in real estate to the other spouse, valid to transfer ownership? (Yes)

…..Does a statement in a couple’s trust saying that any property transferred into the trust is community property make it so? (No)

These are just some of the examples where courts have held that a writing between spouses has either met, or not met, the law’s requirement that for a transmutation to be valid it has to be in writing, “by an express declaration that is made, joined in, consented to, or accepted by the spouse whose interest in the property is adversely affected.” The California Supreme Court has held that there must be language in the writing which shows that the party adversely affected knows that the character of the property is being changed by the instrument.

Even if the language of a document meets the writing requirements for a transmutation, property agreements between spouses must also conform to the fiduciary duties imposed by law. These duties include the requirement that neither party take any “unfair advantage” over the other. Thus, for the transmutation to be enforceable, an advantaged spouse must prove that the other spouse made the agreement “freely and voluntarily,” “with full knowledge of all the facts,” and with a “complete understanding of the effect of the agreement.”

As you can see, this is a difficult and tricky area of the law, and the above are just some of the highlights. If you want to accomplish an enforceable transmutation of any property (or are concerned that something you sign could have the unintended result of a transmutation), be sure to consult with your family-law attorney before signing on the dotted line!

Financial Awareness is Critical in a Divorce

A situation that we commonly see when a person comes to us for advice about divorce is that he or she has let the other spouse handle all the financial affairs throughout the marriage and is therefore not knowledgeable about the couple’s finances. This used to be almost exclusively a problem for wives, but we are now finding it is sometimes the husband who is in this situation (when the wife has been the primary career person). Here are some thoughts to keep in mind:

Even though you are intelligent, even though you are financially comfortable, even though you think you will never need to be financially savvy, you need to protect yourself—through knowledge and information.

Know where all the account records are (bank statements, brokerage account statements, IRA and 401K statements, and records of investments). Keep them in a safe place.

Retain copies of all tax returns, including all schedules and attachments.

Check on whether your name is on all real estate, and keep the deeds in a safe place.

If your spouse is employed, retain copies of pay stubs (especially year-to-date stubs).

Retain copies of all estate-planning documents, including wills and living trusts.

Know how to gain immediate access to safety deposit boxes.

If you have received an inheritance or any large gifts, keep the records (copies of the checks, letters of transmittal, or other transfer documents) in the event that you will one day need to trace back to them.

If you want to retain an inheritance or large gift as your separate property, keep it in an account in your name alone, and do not commingle it with joint funds.

If all of your charge accounts are joint, obtain one or more charge cards in your name alone.

Prepare a list of your monthly expenses, and your family’s monthly income, so that you can see how much is coming in each month, and how much is going out.

Know what financial records are on your home computer, and know how to access and copy them.

The above information is important not only for your own financial knowledge, but it is also important information for you to give to your attorney should the need arise.