1. A Business Is an Asset
Though the spouse who owns the business may feel proprietary over it, a business is an asset. And because it is an asset there must be a determination of whether it is separate or community property, or a combination of the two, and a valuation of the business. However, these determinations are not easy to make.
2. What Type of Business Is This
- A community business is one that is started during the marriage.
- A separate property business is generally one that is started before the marriage or a business started during the marriage with separate property funds. This may have a community interest, but is separate property.
If a spouse establishes or acquires a business with separate funds, there will need to be a tracing in order to apportion the separate property and community property interests. If the party making a separate property claim cannot perform an adequate tracing, the business investment will be presumed to be entirely community property. Note that any increase in the value of a business or profession attributable to community skills, efforts, or industry is community property.
3. Dividing a Business Practice Is Difficult
Disposition of community property small businesses or professional practices can be problematic in a dissolution because (1) it is not usually possible to divide a business or practice in kind and often not possible or permissible to sell it, and (2) a business or practice is usually difficult to value.
Businesses that rely primarily on the personal skill, services, or reputation of the operating spouse typically cannot be divided between the spouses from a practical standpoint. The law may even prohibit such a division, as in the case of a professional practice that requires the owner be licensed to operate the business. If the business will be awarded to one spouse, the court must determine the value of the community interest in the business.
4. Valuation is Difficult, But Key to A Fair Division of Property
The valuation of a business can be a hard and time-consuming process. Generally, a business’ value derives from the worth of its fixed assets (if any), its accounts receivable, its liabilities, and, in some cases, “goodwill.” Using this information, there are three primary ways to find its value: asset approach, income approach, or market approach. Briefly:
- The asset approach uses a formula of assets minus liability to reach a value.
- The income approach looks at the profit or income generated by the business.
- The market approach calculates value by comparing the business to similar businesses that have recently been sold.
It may be best to pick someone who is neutral to do an evaluation for you. If a recent valuation has been done on the business that could be very helpful. However, in cases involving large and complicated businesses, it is advisable to hire an independent forensic accountant who specializes in family law matters to analyze the business for valuation purposes.
5. What to Request from Your Spouse Who Owns a Small Business Checklist of Documents:
Records from the 5 years before the date of value of the business or practice at issue, including:
- Federal and state income tax returns
- “QuickBooks” or other electronic data file, if it exists
- Year-end financial statements (prepared by a CPA, if available.)
- Records from last year and the current year, including:
- Interim financial statements
- General ledgers
- Records as of a date nearest to the date of value of the business or practice at issue and the most current fiscal year-end, including:
- Year-end detail and aging of accounts receivable
- Year-end detail and aging of accounts payable
- Year-end listing of all fixed assets at detail level
- Permanent records, contracts, and agreements, including:
- Life insurance policies for all key employees or officers
- Lease agreements for all facilities occupied
- Articles of incorporation with all amendments, entity bylaws or operating agreement, and shareholder agreements
- Any other legal agreements
- Reports of any consultants or appraisers made within the past 5 years
- Listing of any transactions in company stock since inception
- Previous offers to purchase company assets or stock
- Any business plans, forecasts, projections, or budgets prepared in the 5 years before the date of value