For many divorcing couples, questions can surround one spouse’s ownership interest of a business and how that interest should be divided. In determining the value of a spouse’s individual ownership interest, the total value of the business must first be determined. While not an exact science, three general approaches are used to determine value: cost, income, and market. Each of these different approaches contains various methods that can produce varied results. Generally, the results are averaged to come up with one valuation.
The cost approach is based on the idea that the economic value of an asset is determined by the cost of an equally desirable substitute. For example, if a buyer wanted to value a lemonade stand, he or she could look at the cost of starting an identical lemonade stand, factoring in expenses such as location, equipment, personnel, and start-up costs.
The income approach is based on the principle that an asset’s value is a function of the income that may be expected from the business in the future. An appraiser may calculate a multiple of historical earnings to determine value.
The third method is the market approach, which is similar to how a real estate agent would value a home based on “neighborhood comps.” A business appraiser can draw information from actual market transactions of similar companies in order to reach a valuation, and make adjustments for any comparison factors that have differences.
A recent Oregon Court of Appeals case discusses issues in valuation. In Rodenbeck and Rodenbeck (Or. App., 2011), the wife had appealed the lower court’s ruling challenging the trial court’s valuation of her husband’s ownership interest in a business.
In issuing its ruling, the trial court had relied on the opinion of one of the husband’s witnesses about the forecasted income over the next year. The witness, an owner in the company, was not an expert appraiser and essentially stated to the court that his opinion as to income was more of an educated guess. The husband’s expert appraiser had used all three market approaches, as well as the non-expert opinion of income, as the basis for his valuation. Following a similar approach, the court based the company’s forecasted income on the non-expert opinion.
On appeal, the higher court found that the most persuasive valuation was the expert’s valuation before he factored in the non-expert’s opinion as to projected income. The court stated, “We are not persuaded that a valuation based on an off-the-cuff forecast by a non-expert, who very clearly acknowledged that he was guessing, provides a more accurate value of the company than a value generated exclusively from historical figures.” The court found that the company’s value was, in fact, much higher and therefore increased the award to the wife for her half of the business.
The lesson to be learned is that if you or your spouse own a business or have an interest in a business, retain the service of an experienced, competent business appraiser knowledgeable in the various valuation methods. Finding a logical and sensible way to value the business is the only way to make sure that your divorce award is fair and just.