Written by: Manjula Shaw, CFP®, CDFA®
“Tips from the Trenches” is a series of articles based on conversations with professionals who work with individuals facing or considering the prospect of divorce. Watch this space for conversations with professionals in family and collaborative law, such as forensic-certified public accountants, mediators, marriage counselors, family court judges, and valuation specialists.
Manjula Shaw is a Certified Financial Planner (CFP®) and an Asst. —Vice President at Tanglewood Legacy Advisors. Manjula is also a Certified Divorce Financial Analyst (CDFA®) specializing in helping individuals navigate the financial complexities of late-stage divorce, including asset division, alimony, and child support. She is trained by Collaborative Divorce Texas as an independent, objective financial expert committed to helping divorcing couples and families navigate competing and shared needs and develop solutions that best fit the parties and their children without court intervention.
Manjula’s conversation is with Eric Haverkamp. He is a Certified Valuation Analyst (CVA®), a Certified Divorce Financial Analyst (CDFA®), and a Collaborative Divorce Houston and Texas member. He is a Partner at Hancock Firm, Valuation Advisors. Eric’s expertise is in the valuation and testimony of small and mid-size businesses in divorce situations.
Divorcing Couple Needs to Divide their Privately Held Business – What Next?
For a divorcing couple, owning a business can complicate the divorce process. Often, a business is a large part of the marital estate and is illiquid. Plus, it may be a primary source of the couple’s income. If the company is considered a marital asset that needs to be divided between the spouses, properly establishing its value is crucial.
According to Eric, the standard of value for divorce in Texas is the business’s fair market value, which is the price the company would sell for if both the buyer and seller know what they’re doing and aren’t being forced to make the deal. It’s what a reasonable buyer would pay, and a reasonable seller would accept. Eric has come across some divorce lawyers who may disagree on the point. For a closely held business, the generally accepted value may involve discounts. For example, the discount for lack of marketability (DLOM). This reduces a private company’s share value because it’s harder to sell than shares in a public company. Since finding a buyer on short notice could be challenging, the company may be worth less, and this discount reflects that lower value. Eric says the value of the discount could be a point of contention during a divorce.
In a contentious divorce, characterization could also become a “big issue.” Eric’s business owner client inherited a business from his family pre-marriage. As an inherited property, the business is characterized as separate property. During his marriage, the business owner shuffled equity in the business, giving himself more shares than the number he inherited. As a result, a portion of the company value needed to be treated as community property.
When valuing a business, it’s best to consult a business valuation expert familiar with the family law code in your state. According to Eric, personal goodwill in a business is considered separate property in Texas. Personal goodwill is the value attributable to the individual’s knowledge and skills. Essentially, “What portion of the business directly results from the owner’s efforts?” In a worst-case scenario, “if the owner was to leave the company, what would happen to it?” According to Eric, the (family law) court cannot force the business owner to continue to work at a business. Because of this, one should not be expected to divide this value. Determining the part of the business directly due to the owner’s efforts and the potential impact on the business if they depart are central considerations in a divorce.
For example, Eric’s client owned a business selling medical sponges for advanced back surgery. The company achieved impressive sales revenue through strategic partnerships with a leading physician. As the sole proprietor and employee of the business, the client was allocated 90% of the firm’s value to personal goodwill. This valuation was explicitly recognized as the business owner’s separate property. It was not subject to division during their divorce proceedings.
The owner’s reputation and relationships are crucial to their income in professional service firms. This is especially true for doctors, solo attorneys, and other independent professionals. A significant part of the value could also come from the owner’s goodwill in larger privately owned businesses.
In a larger business, disputes about personal goodwill often arise in divorce situations. For example, one person may argue that 80% of the company value is due to personal goodwill, while the other may claim only 30%. In these cases, the actual value is often decided through mediation and may land somewhere in the middle. Eric observes that in some instances, determining personal goodwill may not be done through a transparent, scientifically-backed methodology just because of the nature of the concept of goodwill. Therefore, it’s essential to be prepared for potential disputes and to approach the valuation process with a clear understanding of the complexities involved.
Stay tuned to read the steps and tools used in a valuation process.
Please reach out to Manjula at mshaw@family-cfo.com if you have any questions.
Manjula’s blogs on all topics divorce Blog – Family CFO (family-cfo.com)
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