In my practice, much of the emphasis on this blog is placed on complex child custody litigation, and how to manage these difficult issues with child custody litigation. Yet, in some of my cases along with child custody issues there can be significant financial issues and division of property issues. One issue that sometimes arises is the valuation of a family owned business, or the valuation of a percentage share in a corporation our group of companies.
With certain exceptions all property acquired during marriage through the time, skill and efforts of either spouse is considered marital property. The disposition of property is governed by Section 503 of the Illinois Marriage and Dissolution of Marriage Act (IMDMA). Under Illinois law, all property acquired by either spouse during a marriage is presumed to be marital property.
A business begun by one spouse after the date of marriage and before physical separation will need to be divided in a dissolution proceeding, and if you and your spouse cannot agree on its value it may need to be evaluated by an expert. Under the IMDMA the Court can appoint its own expert to advise it about financial issues in a case, but more typically each arty will retain a CPA-level expert to determine values in the business and property interests, and then be available to testify at trial (if necessary) regarding the values that the Court should determine in a marital estate.
There are a different methods that can be employed by an expert to value a business or other enterprise, and depending upon whether the business sells services or products different valuation methods may be more relevant than others:
- Comparable sales of similar businesses
The specific asset is valued based upon the listed sales of similar companies with actual sales disclosed in a database of private company sales. Whether this method is useful depends very much on the characteristics of the business – sometimes there is a minimum of published information concerning similar businesses. Comparable sales are also considering in setting the value of real estate.
- Liquidation value
Sometimes businesses will be divided into assets that are sold separately. Liquidation value does not generally include valuing goodwill (because the assumption is there will be no on-going concern). Goodwill is the value attributed to the intangibles that a specific owner brings to the business.
- Capitalized revenues, discounted cash flows or net income
This is the most common method for valuing businesses used in Illinois because this method tends to be the most reliable and most reasonably accepted form of business valuation.
In general, the discounted cash flow method provides greater flexibility if management expects short-term fluctuations in growth, revenue and expenses, leverage, working capital needs, and capital expenditures.
More established businesses with stable earnings may generally find it reliable to apply the capitalization of earnings method. This method is also convenient when valuing a business for divorce litigation purposes because some professional believe the capitalization of earnings method is often easier to explain to a judge than a discounted cash flow model.
These two methods are exclusive of one another. In other words, their results are never averaged together to form a statement of business value.