People involved in the latter types of endeavors frequently claim that the business isn’t worth anything because it does not own anything, it has no inventory, or it can’t be sold. None of those claims generally end the discussion. While the client (or non-owner spouse) may be clueless as to if or how such a business interest can be valued, their lawyer should not be totally in the dark. Lawyers frequently need the help of experts on issues of valuation. The goal of this issue is to aid the practitioner first in determining what type of expert might be needed and then in understanding the information and conclusions the expert might provide.
An initial challenge will be in understanding types of experts who may be involved in a valuation. “The Alphabet Soup of Business Valuations” has been written by Joseph Emanuele and Tracy Farryl Katz. They include the primary business valuation credentialling organizations in the United States and explain that family lawyers should understand the differences between these designations so they can choose the right professional for the right family law case.
William C. Dameworth and Kelly A. Schmid have provided “Understanding Business Valuation Approaches and Methods: A Comprehensive Guide for Attorneys.” The authors break down the three primary approaches used in business valuations—the income approach, the market approach, and the asset-based approach—and the various methods under each. As they note, knowing the differences between these business valuation approaches can help family lawyers better navigate cases involving mergers and acquisitions, partnership disputes, divorce proceedings, and estate planning.
The business participant who insists there is no value because the business cannot be sold is not entirely incorrect. “The Role of Control and Marketability Discounts in Business Valuation” is discussed by Lukasz Kustra. As the author relates, discounts, in the context of business valuation, refer to downward adjustments to the calculated value of an interest in a company to reflect certain inherent limitations or risks associated with either the ownership interest or the marketability of the interest. He explains the two main types of business valuation discounts—lack of control of the interest being valued and marketability of the ownership interest being valued—and how each type is often applied together in fair market value valuations of closely held businesses.
Gregory M. Clark’s “Standards of Value: How Is Value Defined in a Business Valuation?” details the three main standards of value in business valuation for family law matters: fair market value, fair value, and investment value. He explains that standard of value in family law matters begins with the premise of value, which falls under two categories: (1) value in exchange, which considers a hypothetical transaction where the business or business interest is exchanged for cash, and (2) value to the holder, which considers the value of a business or business interest in the hands of its owner.
A business valuation can be a document-intensive process. “Discovery of Documents and Information Used by Business Appraisers and Forensic Accountants in Family Law Matters” has been provided by Glenn S. Liebman and Brandon T. Warshall. The authors outline the relevant considerations, including the necessary documents and information needed by appraisers for the valuation of a business or business interest as set forth by the American Institute of Certified Professional Accountants. They note that the explosion of electronic discovery (e-discovery) in litigation carries with it hurdles for the financial experts regarding the qualification, relevance, reliability, and authenticity of the information that forms the basis of their opinions.
In “Choice of Business Entity: Corporations and LLCs” by W. Y. Alex Webb, the author discusses the critical choice of business entity for any businessperson, including credit protections and tax implications. He focuses his discussion on the key differences between C Corps, S Corps, and limited liability companies, noting that there are many other types of business entities, especially for foreign business entities. He explains that the C Corp is the entity of choice for large business structures, but that S Corps are popular with small business owners due to them having only one level of tax for S Corp owners: the individual tax at the shareholder level and no entity tax.
In their article, “Forensic Analysis and Review of Proper Documentation for Business Valuations,” James Godbout and Brian Schwerdtfeger provide a detailed overview of the documents typically required for a business valuation, including financial statements, tax returns, detailed general ledgers, accounts receivable and payable aging reports, contracts and agreements, business plans and projections, organizational documents, employee payroll records, and bank and credit card statements. They list the steps involved in the forensic review of financial statements and tax returns for business valuation and provide examples of good and bad general ledger entries.
Bruce L. Richman’s “Personal Goodwill in Divorce: What It Is and How One Can Value It” discusses the important distinction between personal and enterprise goodwill when conducting a business valuation as part of a divorce proceeding and how understanding it can have a significant impact on the ultimate value of the company to be used by the courts. He offers a helpful table illustrating how various states consider the concept of personal goodwill when valuing a business in divorce and urges attorneys and clients to work closely with the valuation expert to address goodwill when the valuation of the business is a key part of the marital estate.
Getting a valuation report is only part of the process. The lawyer then needs to understand what has been provided. “Dissecting a Business Valuation Report: What to Look for in the First Read Through” by Charles W. Clanton gives a plethora of elements to look for the first time you read a business valuation report. First and foremost are the qualifications and certifications of the appraiser. Other details to watch for include compliance with the standard of value that was employed in the valuation, sources of information, correct time periods, the business valuation approaches and the appraiser’s rationale for the weight given to each method, and much more.
Once a business interest has been valued, the challenge becomes what to do with that information. Alicia Jurney shares the “Challenges in Distributing Closely Held Business Interests in Divorce.” As she states, the primary question is whether the business interest is separate property belonging solely to one spouse or marital property subject to valuation and distribution. Among the topics she explores concerning in these highly complex cases are the examination of a company’s governing documents, which may contain provisions restricting or triggering the transfer of ownership upon certain events, including divorce; the distribution of the marital portion once the value of a business interest is determined; and ancillary litigation risks.