Little Shop of Horrors: Dealing With Your Business In Divorce (Part 2)

By Jennifer M. Paine

Attorney, Cordell & Cordell, P.C., Detroit office

Note: This is Part 2 of a three-part series on dealing with your business in divorce. Click here to read Part 1 and click here to read Part 3.

If you are a small business owner, dealing with your business in your divorce could send you spinning into a scene from Little Shop of Horrors.

Except, instead of a carnivorous plant reeking havoc on your business, your attorney and your soon-to-be-ex could be crying “Feed Me!” Cash, that is, and lots of it.

How can you avoid this scene and deal with your business effectively? Here are some suggestions.

Choose Your Valuation Method

Next, choose your valuation method.

Choose wisely. Choose the wrong method, and you could over-value the business and shell out more cash to your ex than due, or under-value it and lose your credibility, or pay more to your expert business appraiser than the business is worth.

At a minimum, the valuation should examine the business’s assets and liabilities (its book value), earnings history and potential, dividend and salary capacity, goodwill and other intangibles, industry, economic environment, stock sales, comparables and performance during the marriage. See Rev Rul 59-60.

But, no surprise, divorcing spouses and their attorneys have a remarkable capacity to make the difficult even worse. For business valuations, this means choosing a method that focuses on certain factors at others’ expense to generate the value most favorable to their position.

For the SBLS-afflicted, a favorite method is the fair market value method or the going concern method. This method treats the business as an item of property sellable on the open market. The value is what a willing buyer and a willing seller, neither under a compulsion to act and both adequately apprised of the facts, would use.

But where the demand for the unique business (e.g., a stamp shop) or dime-a-dozen one (e.g., a Detroit diner) is low, so is the value. This is true for most family businesses. SBLS-afflicted spouses make it even moreso by purchasing expensive equipment, taking out a hefty loan, making a risky investment, or otherwise incurring debts that put the business’s book value in the red.

Therefore, the hypothetical sale might look more like a “going out of business” going concern sale. The hypothetical purchase price is low, and for the SBLS-afflicted that is ideal. After all, there is less value to divide if no one will buy the business – and no one wants to buy a business bad in debt, at least, not for much.

For the SYTS-afflicted, a favorite method is the capitalization of earnings method. This method treats the business as a stream of income valuable to its owners, if not to buyers in the open market.

The value is what an investor would be willing to invest in a comparable risk to generate the same income. It is the product of the projected income steam and a capitalization rate (a risk multiplier).

The capitalization rate is based on the rate of return for similar investments, the risk and the business’s historical earnings, among other things. SYTS-afflicted spouses make the cap rate as high as possible by comparing the business to lucrative ones (That hardware store is just like The Home Depot!), minimizing risk (Nothing’s as reliable as this business!) and glossing over low earnings years (Nevermind that low profit; look at the business trips, meals and clothes we got that year!)

After all, the more the business generates for its owners, the more valuable it is – and the more to divide in divorce.

 

Note: This is Part 2 of a three-part series on dealing with your business in divorce. Click here to read Part 1 and click here to read Part 3.

 

Jennifer M. Paine is an Associate Attorney in the Detroit, Michigan office of Cordell & Cordell P.C. She is licensed to practice in Michigan, and has been admitted pro hac vice in Illinois, Ohio, and the United States Court of Federal Claims. Ms. Paine received her BA in English and Mathematics from Albion College and graduated Summa Cum Laude. She received her Juris Doctorate from MSU College of Law and graduated Summa Cum Laude.

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