Business Valuation in Divorce

I. Overview of Business Organization Structures

When a married couple gets a divorce and one of the spouses owns a business that business is often an asset owned by the marriage and the value should be divided. A business can be created in different forms. The most common forms are sole proprietorship, partnership, corporation, and S corporation. The form of the business entity can have effects on taxation, ownership, and how it is divided.

A sole proprietorship is a self-owned, unincorporated business. If a party is the owner of a sole proprietorship, then the business is dividable upon dissolution of marriage.

“A partnership is the relationship existing between two or more persons who join to carry on a trade or business. Each person contributes money, property, labor or skill, and expects to share in the profits and losses of the business.” Each partner in a partnership shares in the profits and losses and the income passes through to the partners without taxation to be included on their individual tax return.

Corporations are owned by shareholders. Shareholders exchange money for the corporation’s capital stock. Profits are distributed to shareholders as the owners of the corporation. S Corporations pass corporate income and losses to their shareholders. This is for tax reasons.

A Limited Liability Company is allowed by state statutes. The state may choose its regulation. Owners of an LLC are called members. Members may include individuals, corporations, other LLCs and foreign entities.

When conducting business valuation for divorce it is important to know what structure the business has in order to best value and divide the worth.

Often, the largest asset in a case where one spouse owns a business is the business itself, and often the biggest assets of that business are not liquid. Marital property and debt is to be divided in accordance with the law in your particular state. However, in a general sense, in a dissolution of marriage action, assets and debts have to be divided in a just manner or as set forth by the laws in your state. In order to achieve a just division, it is vital to have a business properly valuated to achieve that end. Common issues are then:

Valuation disputes: The standards are often governed by local rules. Typically, valuation is considered to be Fair Market Value (“FMV”), but even how FMV is calculated or what can be considered in FMV varies by jurisdiction.

Division of the business: Will the business be able to continue operating if forced to liquidate assets?

Tax ramifications: Section. 1041 of the Internal Revenue Code states: “no gain or loss shall be recognized on a transfer of property from an individual to (or in trust for the benefit of)-(1) a spouse, or (2) a former spouse, but only if the transfer is incident to the divorce.” According to Sec. 1041(c), a transfer is incident to the divorce if it occurs within one year after the divorce or “is related to the cessation of the marriage.”

A practicing divorce lawyer will typically confront several typical interests in closely held corporations. These interests can be: (1) stock in the corporation; (2) membership in an LLC; (3) a partnership stake in a partnership; or (4) an ownership interest in a closely held family business.

Being able to represent a client who is either the business owner or the spouse of the business interest owner requires a basic ability to read business statements. Here are a few basic starting points. A “C” Corporation must file a separate tax return. Income earned by corporation that does not flow through to an individual’s return, except to the extent that a spouse is paid wages or compensation that will be on the spouse’s W-2 or 1099 forms. On the other hand, “S” Corporations, LLC’s, and Partnerships must file informational tax returns. There, income earned from these entities flows directly to the taxpayer and will be reflected in the individual’s tax return. Income from a single-member LLC should almost always be reflected in a Schedule C of the individual’s tax return. For a closely held family business, some basic documents are: (1) Corporate or Partnership Tax Returns; (2) Periodic Profit and Loss Statements; (3) Balance Sheets for the Business Entity; and (4) Inventory Reports, Accounts Receivable, Accounts Payable, Buy-Sell Agreements.

II. The Valuation Process

One option is to sell the business and divide the profits. The pros of this option are that both spouses may profit from a sale of the business and can use the proceeds to invest in their own business ventures. Plus, spouses can avoid additional financial ties to their ex-spouse. The downside is that this could take some time; many businesses can’t be sold easily and it may be months before a buyer is found.

A second option is to buy-out the other spouse’s interest. In a buyout, one spouse keeps the business and buys (pays for) the other spouse’s interest. A buyout may be the best option assuming there are sufficient assets to complete the transaction. This can be accomplished if the buying spouse has enough cash or liquid assets available to pay off the selling spouse. Alternatively, the spouses could offset the selling spouse’s portion of the business with other assets, for example:

The equity in a home
IRAs or 401(k) plan assets – however, these should be calculated at their estimated after-tax value in order to compensate for the eventual tax on withdrawals.
Securities outside of qualified plans may be the most desirable in offsetting the value of a business because there is little to no tax liability associated with these accounts.

If the business comprises most of the couple’s net worth, the spouses may have to enter into a “property settlement note” or “structured settlement,” which will be paid out over time to the selling spouse. A property settlement note is similar to a note at a bank – it should have a reasonable rate of interest, a definite term, and a principal amount.

A third option is to dissolve the business. Dissolving business partnerships is governed by state law, so check your state’s website for information about the process and the forms you need to complete. It usually takes 90 days from filing a statement of dissolution (usually a simple one-page form) to dissolve a partnership.

The process ensures that neither partner will be responsible for the other’s debts and liabilities and, once dissolved, that neither partner can enter into any binding transaction on behalf of the partnership. It also renders your original partnership agreement void.

Before you file any paperwork with your state, make sure you review your current business:

Have you or your partners completed all agreed duties?
What is the business worth? A third-party valuation can help you develop this figure. Once your partnership is dissolved you can typically expect each partner to assume business assets and liabilities based on percentage of ownership.
Review all leases, contracts, and loan agreements to see how the dissolution will affect them. For example, are you locked into a contract period regardless of your partnership status?

Once the partnership dissolution is in process, draft a dissolution agreement with the help of a lawyer. This will outline the terms of the split and protect you against any future disputes or claims that might be brought against you.

A. Tracking Down Hidden Assets: Savvy Tips and Tricks

Probably the best tool for tracking down cash and other hidden assets are tax returns. This is because even a spouse who is attempting to hide assets or income through their business was probably not considering such action seven, five, or even three years ago. The first line of 1040 can be important because it provides a social security number which can be used for other searches. The W-2’s for the spouse as an employee can also be important. How does the past compare to the present? Bank Statements and Credit Cards can also prove to be equally valuable. There are several key things to look for in this regard. Do deposits match invoicing or account receivable? Are wages to relatives or close friends comparable to others performing similar tasks? This can be common where there is an anticipation of the funds being gifted back later. Do known expenses not being paid out of any account signify cash transactions? Were abnormal bonuses paid out? Stock options? Do you know of personal use of company assets or perks? What is the value? Are there any transfers or deposits from unknown accounts? Do check registers or cancelled checks show previously unknown accounts? Are regular customers now late with payments delaying income? Has there been a sudden increase in liabilities or loans? An expert’s cash flow analysis may uncover the answers to many of these questions. Hiring a forensic accountant or private investigator can also help to uncover hidden assets. You can also try to talk to other witnesses who may have an idea of where hidden income is coming from, such as business partners.

The difficulty with cases involving alleged hidden assets is avoiding the assumption that hidden assets do, in fact, exist. When seeking hidden assets, it is first necessary for investigators (whether it be one of the divorcing parties, the attorney, or paralegal) to recognize the underlying factor that the possibility of hidden assets must exist before hidden assets can exist. Investigating under the sole assumption that hidden assets exist can result not only in wasted time and costs but also the risk of discovery abuse, such as placing an undue burden on the opposing party (OP). Therefore, the underlying mindset for investigators should always seek the answer the question, “Is it possible that hidden assets exist?”

Whether it is known or merely suspected that the opposing party may be hiding assets and/or accounts, the process should begin by asking the client questions in order to establish a “profile” of the OP. Important questions include, but should not be limited to:

Does the OP own their own business/self-employed? This is an important factor because it is often easier and in some cases more likely for an individual that owns their own business or is self-employed to hide assets or maintain offshore accounts.
Please describe the lifestyle you (the client) and OP live or lived. The OP’s lifestyle, or change in lifestyle, can also be an indicator of the possibility of hidden assets/accounts. For example, the OP may make expensive purchases (i.e., cars, homes, etc.) in an attempt to squander funds from hidden assets/accounts throughout the divorce process.
What financial records/documents do you have in your possession and what accounts do/did you share with OP? Answering this question at the onset will be helpful once the discovery process begins so the attorney/paralegal will know what documents to request and where to look.
Do you remain in contact the OP, and if not, do you know their home and work address? While this question may be basic, it is important to maintain a good idea of the OP’s whereabouts in case they attempt to leave town (not uncommon in cases involving hidden assets/accounts).

Collecting basic information about the OP before beginning the discovery process is helpful and will aid you throughout the discovery process. Start with an initial checklist of background of the OP, such as place of employment, date of birth, social security number, and the individual’s last known address. Also consider collecting information regarding the identities of the OP’s close friends and relatives. This can often come into play because they will transfer or hide assets in those individuals’ names in an attempt to avoid detection.

The three primary sources with regards to the discovery process will be tax documents; financial documents including bank and credit card records, insurance policy information, retirement plan documentation, and any investment records; and email & text records. Of course, the relevant discovery requests will vary from case to case but this is a broad overview of the common sources for discovery of hidden assets and is similar to discovery in a standard divorce case.

It is also important to point out other resources which may be useful in a case with hidden assets, specifically forensic accountants and private investigators. While they may be costly, utilizing such resources may be extremely helpful, depending on the complexity of the case. Forensic accountants are especially helpful and often necessary when analyzing tax and financial documents for potential hidden assets.

There are several Tax Forms (other than the 1040) that may or may not be applicable. It’s important to know the standard IRS forms required for offshore asset reporting and their purpose. Other than the standard 1040, there are 7 IRS forms applicable to offshore assets:

FBAR (Foreign Bank Account Reporting ) Form : TD F 90-22.1 (Prior to 2014, FinCEN Form 114 (Present) are required for U.S. citizens who have foreign bank accounts;
Form 8938 -required under the Foreign Account Tax Compliance Act for individuals who own certain foreign financial accounts or assets with a total value of $75,000 or more at any time during the tax year.
Form 3520-reporting requirement for U.S. individuals who receive a foreign gift or bequest valued at more than $100,000 from a foreign individual or estate.
Form 3520-A -required reporting of a foreign trust with at least one U.S. owner to provide information such as the owners of the trust, the value of the owners’ interest, and the FMV of distributions (if any).
Form 5471-Required for U.S. citizens and residents who are officers, directors, or shareholders in Certain Foreign Corporations (CFC).
Form 8621-Required information return by a U.S. citizen or resident that is a shareholder of a Passive Foreign Investment Company (PFIC) or Qualified Electing Fund (QEF).
Form 8865-Required return of U.S. persons with respect to Certain Foreign Partnerships.

However, requesting these tax forms during discovery, either from the individual or the IRS, is only effective if they have in fact been filed. Individuals with hidden assets typically do not adhere to tax reporting and filing requirements, hence the hidden classification. Therefore, requesting these tax forms is only the starting-point. These can be helpful because hidden assets are typically under a false name or entity but the individual is still likely to receive notifications to their personal email or phone. Resources such as a forensic accountant or a private investigator, while helpful, can also become very costly. Using such resources is primarily recommended in situations when it is known that OP has hidden assets in order to better find them.

The key sources of hidden assets include cash-either actual cash or cash converted into property (common method of hiding assets). The rationale of hiding assets is typically to convert an individual’s income, wealth, etc. into forms that are either difficult to discover or perceived to not be of significant value. Assets such as cars and homes are more obvious forms of property with perceived value, but in some cases client may not be aware as to the OP’s possession of such items. Somewhat to the contrary, clients may be aware of various investments, insurance policies, or memorabilia but not necessarily the value of those assets. Either way, these assets, no matter how obvious they might seem, should be considered when beginning the discovery process.

In some cases, assets may be overlooked rather than hidden-that being said, the opposing party may not always disclose such assets. Therefore, it is important to keep an “open-mind” throughout the discovery process; whether through document request, depositions, or interrogatories, consider assets that may be overlooked:

Stock Options & Restricted Stock
Capital Loss Carryover
Cemetery Plots
Collections or Memorabilia
Intellectual Property
Credit Card Reward Points
Country Club, Golf Course and Other Memberships

All of these examples may easily get overlooked but potentially carry significant value. When valuing a business for divorce, it is important to be able to recognize and spot hidden assets.

The following are merely suggestions for how to improve chances of a settlement that is good for both parties and leads to a better resolution for everyone involved, including minor children, there are ultimately many ways and different strategies that can be used for an effective negotiation strategy.

Focus on the future: Divorce can be an emotionally traumatizing time in a person’s life and dredging up the past will not help the client move forward to a resolution for all remaining issues in a divorce action. Directing discussions to what needs to be done in the future and what solutions can help resolve current problems is an effective way to keep the client moving forward towards settlement. Clients will often want to focus on past harms and past issues in the relationship which can lead to roadblocks on the way to settlement.
Avoid sensitive issues: When tension and emotions are running high it is important for the attorney to direct their client away from discussions of sensitive issues. This is connected to avoiding discussions of the past but can also include discussion of which parent minor children would prefer to be with, whether one spouse moved out or was kicked out, and who is at fault for the divorce. Discussion of these topics can be counterproductive to establishing a settlement agreement that is satisfactory for the client and can extend the length of time until settlement.
Focus on interests, not positions: One way to easily use this strategy is by asking your client what their concerns are. This can take the discussion away from who is right or wrong and towards what their specific concerns are that could be resolved through negotiation. For instance, your client is in a gridlock on settlement negotiation with his spouse because he does not want to move out but by asking him what his concerns are he voices that he does not want to lose contact with his children. Discussion of this concern can help direct the conversation in a meaningful way to determine if there is a compromise to be made where your client can move out of the marital home while still maintaining a close relationship with his children that is satisfactory to both parties.

In cases that cannot be successfully resolved or mediated from the beginning, there are diverging views. But generally speaking, in contentious cases where parties do not view the situation similarly, my view is that “peace through strength” is usually the best way to get a client to their goal of a reasonable settlement in a family law matter.

This means that the client allows the attorney to issue discovery such as interrogatories or requests for production. Where other documents or evidence are needed to put forth the best case, this also means allowing an attorney to subpoena necessary documents and witnesses. Where expert testimony is needed to make the best case, (like a business valuator.), then these individuals need to be retained early in the process.

By doing this, the opposing party to a case often realizes that settling is the best bet because you are prepared f or a trial. While it might cost some money for a client on the front end, this can often grease the wheels in the settlement process – and get the other side to come off unreasonable positions – because they will worry that you are prepared. Getting information through discovery is also part of the “due diligence” that is required and can actually help the settlement process in many cases.

In many instances, there are alternatives for people to consider, including collaborative divorce and mediation. In collaborative divorce, each spouse hires a trained collaborative lawyer. Spouses sit down with their lawyers and talk through matters. Often, they bring in additional professionals who can lend their perspectives. These include divorce coaches, financial neutrals and psychologists.

III. Working with the Accountant/Appraiser

Federal Rule of Evidence 702 allows for expert testimony: “If scientific, technical, or other specialized knowledge will assist the trier of fact to understand or to determine a fact in issue, a witness qualified as an expert by knowledge, skill, experience, training, or education may testify thereto in the form of an opinion or otherwise.” Check state statutes for your local rules regarding the qualifications of an expert and the admissibility of their testimony. A Business Valuation Specialist will frequently be allowed to testify in terms of valuing a closely held business and consequently you should consider the use of Business Valuation Specialist in any case involving closely held business. This is particularly true if the business would appear to have some value and you are unfamiliar with business accounting. Remember, that in order to divide marital property and debt in a just or equitable manner, it is critical that all assets be valued, including businesses owned in whole or part by the parties.

It is also important to know at what point in time the evaluation is to take place. For instance, in Goodwin v. Goodwin, the husband’s expert valued the business at the time the wife left the company’s employ arriving at a figure of $385,000. The wife’s evaluator valued the business at a point as close to trial as possible to trial coming up with a figure of $1.65 million. The trial court adopted the latter evaluation, and the appellate court concluded it was within the discretion of the trial court to do so.

Additionally, consider a cost benefit analysis regarding size of business or if spouse suspects hidden business incomes. All too frequently a spouse whose business has performed and provided beautifully for years will suddenly be cash strapped. (Recently Acquired Income Deficiency). To help identify such spouses consider the use of several types of financial experts. Accountants can help examine cash flow, value business perks, and discover hidden or unreported income. Business and Practice Appraisers can be used to determine the fair market value of a business or practice. Financial Planners can help identify the true value of investments going forward and Real Estate Appraisers as well as Vocational Experts may prove useful too. The key to the use of these experts is that you know both the expert and their report.

It is also vital to tell the expert at the onset what you might be looking for and the purpose in hiring them. Knowing what you’re looking for will help you determine whether the expert is capable of identifying that information for you. In other words, you need to know the strengths and weaknesses of the expert. For this, you will want to see their curriculum vitae, discuss their potential biases, and ask about their general experience with testifying in court.

You will also need to be able to identify the strengths and weaknesses of the report. If you do not already understand, ask the expert for an explanation of the methodology used and alternatives which could have been employed. Prepare the expert for direct and cross examination of their findings and be prepared to impeach the opposing parties’ expert in terms of the substance, their own biases, and on their experience. For instance, did they comply with methodologies in Rev. Rul. 59-60? Did they substitute book value for fair market value?

A. Sample Questions to Ask Business Valuation Experts on Examination

First, it is important to ask about the methodology, assumptions, procedures and how the opinion of value was determined. The following are some examples of potential other questions to ask.

Have you personally sold a business or assisted a client in buying or selling a business in the same industry? How many have you sold?

Asking the expert if he or she has sold businesses in the past is directly aimed at the expert’s experience and knowledge on real-world issues. An expert who has sold businesses has firsthand knowledge of the selling process and is likely to have a better understanding of the marketplace. An attorney should be on the lookout for a business valuation expert who is purely theoretical and has little knowledge about buyers and sellers in the real world.

Do you know for certain if the amount you concluded to be the value of the business can be financed?

A good business valuation expert will consider more than one method as a check for reasonableness. And a great business valuation expert will take one step further by determining if the purchase price can be financed. If the opposing side’s expert determines a value for a business that cannot be paid off in five or seven years while also returning a reasonable amount to the owner, it is probably not a realistic price to pay for that business.

Does your valuation comply with generally accepted accounting principles?

Some valuation experts are stumped by this question. Generally accepted accounting principles do not govern the valuation field. However, there are well-accepted valuation principles such as Uniform Standards of Professional Appraisal Practice and Statement on Standards for Valuation Services.

Did you conduct a site visit? If so, when?

Generally, site visits are important to a business valuation but this question is often overlooked by attorneys. If the expert did not conduct a site valuation, how do they know what they were valuing didn’t just vanish into thin air? A site visit must be performed to physically observe the valuation subject and corroborate those observations with the information obtained from the management interview and financial records. Trust but verify.

From your previous valuations, has any value you determined ever been substantially changed in a court decision? Has the value stood up in court?

This question further discredits the expert by showing the judge or jury that the expert’s been wrong in the past.

Have you ever been excluded as an expert? Has your testimony ever been excluded?

This is a direct hit at the expert’s credibility if he or she answers yes to this question.

Who hired you and how many times have you worked for them?

It’s all about perception. If the expert admits he or she has been hired by a client over and over again, the perception is that the expert will conclude a value to the client’s satisfaction whether or not it represents fair market value.

You advertise yourself as an expert for hire, is that correct?

The intent of this question is to show the judge or jury that the expert is a “hired gun” and is likely an advocate on behalf of his or her client. The value may be skewed to favor their side and may not represent fair market value.

How much of your professional time is devoted to expert testimony?

Score one for your side if you cross-examine a business valuation expert who spends more time on the “expert” part than the “business valuation” part. This kind of “expert” likely will be seen as an expert opinion for hire.

IV. Standards of Value

The first thing to understand is “Fair Market Value” and what this term encompasses within your jurisdiction. The common definition for fair market value is “the price, expressed in terms of cash equivalence, at which property would change hands between a hypothetical willing and able buyer and a hypothetical willing and able seller, acting at arm’s length in an open and un restricted market where neither is under compulsion to buy or sell and when both have reasonable knowledge of the relevant facts.” The first place to look for your definition of value are state statutes, but often these can be confusing and require an examination of case law on the topic.

One of the toughest aspects in evaluating a family business is the “goodwill” of the business and some states include various types of goodwill in Fair Market Value Analysis. Some courts will differentiate between “enterprise” and “personal” goodwill. Personal goodwill (also known as “professional goodwill”) attaches to a particular individual rather than to the business that the individual owns. Enterprise goodwill (or “business goodwill”) is derived from characteristics specific to a particular business, regardless of who owns or operates it.

Twenty four states and the District of Columbia exclude personal goodwill from the marital estate; nineteen states include personal goodwill in the marital estate; and eight states have no formal precedent. As a general rule, if the buyer would pay very little for the business, due to expected losses of repeat customers or specific referrals to the newly formed competing entity, this points to a high degree of personal goodwill. If the selling owner would be unlikely to siphon business away from the entity that he or she sold, then there would likely be a higher degree of enterprise goodwill.

The common argument for the inclusion of good will in Fair Market Value is that otherwise the court is ignoring the contributions of the non-professional spouse to the creation of the professional spouse’s business, earning capacity, and career. Common arguments against the inclusion of good will are that it is highly speculative, results in inflated values, and requires the professional spouse to compensate the non-professional spouse of earnings he or she may never acquire.

For an example of the importance of properly valuing a business, look at Wood v. Wood. This case involved a valuation of closely held company performed by both the husband’s and the wife’s competing experts. The husband’s expert engaged in a full assessment of the company to determine FMV while the wife’s expert relied on a Buy-Sell Agreement’s formula to determine the company’s value and the husband’s interest. The majority opinion found that the trial court misapplied the law in relying on wife’s expert because of the failure to determine fair market value. The mistake for the wife was costly as the court adopted the husband’s valuation at $325,000 as opposed to the wife’s valuation at over one million. The dissent stated that a Buy-Sell Agreement is an accepted methodology for valuing goodwill. A closely held company, like goodwill, is difficult to value but the methodology was acceptable and the trial court was entitled to rely on it. While the dissent did not prevail here, pay attention to the dissenters, for they may become the majority a la Justice Hugo Black in Betts v. Brady, 316 U.S. 455 (1942) and Gideon v. Wainwright, 372 U.S. 335 (1963).

Another common issue is the application of Fair Market Value to professional practices or businesses that cannot be sold either by law or by contract. In Hamby v. Hamby, the court concluded that the husband’s insurance practice, which was inalienable pursuant to his agreement with Nationwide, still had a fair market value. Fair Market Value represents a “hypothetical” sale for equitable distribution purposes, the fact that the business could not be sold in real life was immaterial, and thus the value of the business was more than the agency’s fixed assets. In contrast, in In re Marriage of Robert E. Zeigler, the court held that the husband’s “captive” agency had no goodwill as all goodwill belonged to the parent company, which was State Farm. Valuation was essentially limited to his income which was a result of his “skill, knowledge, and hard work.” Goodwill was separate and belonged to company. Therefore it is again key to examine the precedent in your jurisdiction when conducting or cross examining a business evaluator.

The following are a few basic concepts and terms in forensic accounting:

Market Approach: Valuator tries to locate guideline businesses that have been sold in order to make a comparison of value. Similar to appraising of residential real estate, but can be difficult to use for small closely held businesses.

Asset Based Approach: Each component of the business is valued separately. Valuator estimates value by estimating cost of duplicating or replacing individual elements of the business. This approach cannot be used alone if there are intangible assets with value.

Income (Income-Based Approach): General way of determining a value indication of a business, business ownership interest, security or intangible asset using one or more methods that convert anticipated economic benefits into present single account.

Capitalization of Earnings: A method within the income approach whereby economic benefits for a representative single period are converted to value through division by a capitalization rate.

Capitalization Rate: Any divisor (usually expressed as a percentage) used to convert anticipated economic benefits of a single period of value.

Minority Discount: A discount for lack of control applicable to a minority interest.

Key Man Discount: Discount for loss of efficiency until someone is sufficiently trained to replace a key man.

Marketability Discount: Discounts for lack of marketability deal with the lack of liquidity of an ownership interest and how quickly and easily it can be converted into cash.

Additionally, on the federal level, Rev. Rul. 59-60 is the touchstone for understanding business evaluations and it also informs the law on a state level. The revenue ruling lists factors for valuation of stock in closely held corporation: (1) The nature of the business and the history of the enterprise from its inception; (2) the economic outlook in general and the condition and outlook of the specific industry in particular; (3) the book value of the stock and the financial condition of the business; (4) the earning capacity of the company; (5) the dividend paying capacity of the company; (6) whether or not the enterprise has goodwill or other intangible value; and (7) the market price of stocks of corporations engaged in the same or a similar line of business having their stock actively traded in a free and open market, either on an exchange or over the counter.

V. Methods and Approaches – Which to Use

A. Income Approach

The income approach seeks to identify the future economic benefits to be generated by an entity and to compare them with a required rate of return. The first step in the valuation process, performed internally or externally, is to determine the future cash flows or “projections”. This will be the responsibility of the company’s management if using an external valuation specialist. The specialist should review the projections for reasonableness. The projections are typically performed for the upcoming five years. Although this is not a hard and fast rule, it is a rule of thumb that is commonly applied. Revenues and expenses should be projected forward from current results. The resulting amount should be appropriately tax affected to determine what the free cash flows of the entity will be. Other adjustments that should be considered are cash related items such as CAPEX, depreciation and amortization, to name a few.

After the free cash flows are determined, the entity’s numerator of the calculation is largely in place. Next, the denominator is the focus. The rate of return, or discount rate, for more developed companies is often determined through the Build-Up Method. CAPM is used in some circumstances, but the inherent difficulty in identifying a “beta” for the CAPM calculation causes many valuation specialists to use the Build-up Method. While this type of approach works for a company with more history, a new company or one just beginning to generate income and free cash flows poses a different challenge.

Investors seeking to assess a younger company may choose not to apply the income approach as it may not be applicable due to a lack of results on which to base projections. However, if there is a basis to work from, using the Build-up Method may not be appropriate. The rate of return for companies that are younger can vary quite a bit. Amounts from 20%-80% are often used for companies that are early-stage. The less risky and more reliable the projections, the closer the rate of return is likely to be nearer to the 20% end of this spectrum. Riskier, younger ventures with less proven results upon which to base the projections may use a discount rate closer to the 80% end of this range.

Taking the free cash flows discussed as the numerator and applying a rate of return, or discount rate, will result in the present value of future cash flows. The sum of these for the five years, based on the reasonable adjusted projections, provides one half of the value to be calculated.

Not many companies will simply end at five years. The valuation needs to also take into account the additional years of cash flows to be obtained. These cash flows can often be even more significant than the five years already detailed out. The terminal value, as this next amount is known, is generated by applying a long-term growth rate to the company’s free cash flows and discounting this total back to a present value as was done with the first five years’ projections. When calculating the terminal value, the growth rate should consider the stage of the company and how it is likely to grow in the future. Many times, the United States GDP can be used as an estimate for this future growth. For well developed companies, exceeding this is unlikely. For earlier-stage companies, exceeding this is not uncommon. The sum of the present values of the five year projected free cash flows and the terminal value provides the total enterprise value from the Income Approach.

The advantages to the income approach are that it is widely recognized, it is flexible in addressing companies of many different stages and natures, and it simulates a market price even if there is no active market. The disadvantages include that it relies on hypothetical projections and it utilizes a discount rate with many variables in determining the appropriate figure.

B. Market Approach

The Market approach is a fundamental method for estimating the value of an interest of a closely-held entity is an analysis of prices paid by investors for companies in the same or similar lines of business. Two common methods are:

The Guideline Transaction Method involves searching databases for transactions in companies that are determined to be similar to the subject company. Ratios from these transactions (ex. price to discretionary earnings) are then applied to the subject company to estimate value.
Guideline Company Method involves searching for comparable publicly-traded companies. If similar companies can be identified, certain ratios relative to these companies (ex. price to earnings) are then used as a basis for estimating the value of a subject company.

C. Asset Based Approach

The asset approach is defined in the International Glossary of Business Valuation Terms as “a general way of determining a value indication of a business, business ownership interest, or security using one or more methods based on the value of the assets net of liabilities.” The approach uses the books of the company to identify the fair value of the assets, both tangible and intangible, and the liabilities to determine a net value for the company. Whereas the market and income approaches both focus on income statement activity, the asset approach primarily utilizes the company’s balance sheet. The asset approach is often utilized when a company is no longer operating as a going concern and is preparing for liquidation. Other times the asset approach can be used is when the business is based on assets, such as an investment vehicle, and not on income, such as a production company.

Steps in employing the asset approach are:

Start with the balance sheet – ideally this will be “as of” the same date as the valuation date
Restate assets and liabilities to fair market value where necessary – this can be the most judgmental step in the asset approach
Identify unrecorded assets and liabilities and what their impact will be on the valuation – these may be off-balance sheet commitments or assets that are not on the balance sheet. name=”_ftnref51″>

Most of the items on the balance sheet are valued in a very straightforward nature. Cash is cash. Marketable securities can also be as easy as cash to value due to a stated market value. Accounts Receivables and Prepaid Expenses typically have a fairly easy valuation. Property, Plant & Equipment (“PPE”) and Inventory of a company can be more difficult to value. These categories of assets should be considered carefully and valued appropriately.

There are times when a third party may be used to value certain elements of the balance sheet. PPE is a good example of this. For example, most valuation specialists are not specialists at valuing land and many companies may own land. The same can be true for a machine used in production. A company may have purchased the machine for one price and depreciated it to another. However, the value of the machine may different from either of these values based on what it could be sold for on the open market.

Liabilities can also provide similar judgmental decisions for a valuation specialist. While accounts payable and many accrued expenses are straightforward in their value due to a specific amount stated on an invoice, a liability such as a warranty accrual or a litigation accrual can be far less clear in its fair value and what it should be carried at during a valuation. Significant consideration should be given to these more opaque items on the balance sheet when performing the valuation.

A last item where judgment may come in to play is with intangible assets, such as trademarks. Self-created intangibles are not put on the balance sheet of a company and therefore do not automatically require valuing and adding to the balance sheet. However, intangibles added through acquisition or purchase may exist and the skills of the valuation specialist need to be considered in whether or not to utilize a third party to value the intangibles.

The simplest way of thinking about the asset approach is Assets – Liabilities = Asset Approach Value. This also equals “Equity” on the balance sheet. This is a very rough view but still a way in which someone could begin to gauge the value of a company through the asset approach before beginning a deeper look into each of the line items of the balance sheet.

VI. Deciphering Valuation Discounts

In valuing minority interests in a business discounts must be considered that affect minority interests. For minority interests, there is no ready market to purchase or sell the interest. Private companies are not too liquid in their assets and equity. Therefore, their value is discounted. Valuation discounts can happen two ways.

Lack of control is one factor that reduces the Fair Market Value. Consider the following: “a limited partner has no control over… managerial decisions… As a result, fair market value analysis, a non-controlling interest in a Family Limited Partnership is worth less than controlling interest.” The IRS permits around 20 to 40 percent discount for such situations. Minority interest discounts are the inverse to control premiums where people would pay more for a controlling share.

Lack of marketability is another factor that reduces value in the fair market value of a Family Business. This is partially because buyers are wary of the potential problems stemming from the family dynamic inherent. Marketability is the ability to convert the business interest into cash with low cost and high certainty. With no established market readily available for buyers and sellers it takes time to connect a transaction. The higher Marketability an interest has, the less time it would take to make the transaction. Marketability is how liquid your interest is.

Whether the reason is lack of control or lack of marketability, these flaws in business ownership are taken into account in valuation. Since there is some cost associated with these flaws, the price is discounted to make up for it. When valuing a business asset for divorce a discount should be given for a minority interest asset.

VII. What to Look for When Reviewing a Business Valuation

A. Tax Issues You and Your Clients Need to be Aware of

Section 1041 of the Internal Revenue Code state: “no gain or loss shall be recognized on a transfer of property from an individual to (or in trust for the benefit of)-(1) a spouse, or (2) a former spouse, but only if the transfer is incident to the divorce.” According to Sec 1041(c), a transfer is incident to the divorce if it occurs within one year after the divorce or “is related to the cessation of the marriage.”

A practicing divorce attorney will typically confront several typical interests in closely held corporations. These interest can be: (1) stock in the corporation; (2) membership in an LLC; (3) a partnership stake in a partnership; or (4) an ownership interest in a closely held family business.

Having an attorney who is familiar with representing a business owner or the spouse of the business interest is vital to ensure that they have at least a basic ability to read business statements. Here are a few basic starting points. A “C” Corporation must file a separate tax return. Income earned by corporation that does not flow through to an individual’s return, expect to the extent that a spouse is paid wages or compensation that will be on the spouse’s W-2 or 1099 forms. On the other hand, “S” Corporations, LLC’s and Partnerships must file informational tax returns. There, income earned from these entities flows directly to the taxpayer and will be reflecting in the individual’s tax return. Income from a single-member LLC should almost always be reflected in a Schedule C of the individual’s tax return. For a closely held family business, some basic documents are: (1) Corporate or Partnership Tax Returns; (2) Periodic Profit and Loss Statements; (3) Balance Sheets for the Business Entity; and (4) Inventory Reports, Accounts Receivable, Accounts Payable, Buy-Sell Agreements.

B. Planning for Retirement Benefits Attached to the Business

Individual Retirement Accounts (IRAs) are typically one of the items allocated in a divorce decree. An IRA is a type of custodial account or trust held for the benefit of an individual or their beneficiaries. It is created by a contract between the bank that manages the account and the owner (i.e. the depositor). Part of this contract includes the beneficiary/beneficiaries who will receive the balance of the IRA upon the owner’s death. The beneficiaries are usually the owner’s spouse or children. Upon dissolution of the marriage, the divorce decree will award the IRA to one of the parties, and whichever party receives it is able to change the beneficiaries. For example, if the husband is awarded the IRA in the divorce, he can substitute his children as the primary beneficiary for his ex-wife beneficiary.

It is important to change the beneficiary on an IRA as soon as possible. Beneficiary designations often trump provisions laid out in a will and if a beneficiary isn’t changed, an ex-spouse can still have access to the IRA. A recent Missouri Court of Appeals case details this possibility. In 1996, the husband designated his wife as a beneficiary of a Fidelity IRA account. The couple divorced in 2000 and husband received the IRA in the property settlement. Several times over the years, the ex-husband contacted Fidelity for information on how to access the Beneficiary Change Form yet he never actually changed the beneficiary. When he died, a fight between his estate and ex-wife ensued over the IRA. The estate cited a Missouri statue that revokes an ex-spouse as the beneficiary on the date the marriage ended. Several states have such statutes, but they have not held up to judicial scrutiny. In the Missouri case, the appellate court referenced a U.S. Supreme Court case that held ERISA governed and overrides or pre-empts state statute to reduce administrative burdens in identifying the correct beneficiary. The circuit court had not addressed the Supreme Court case and instead awarded the funds to the estate based on the intent of the ex-husband. The Court of Appeals reversed and remanded the case to the circuit court with the specific instruction to enter a judgment in favor of the ex-wife including costs and attorney’s fees.

This case is just one of many where failure to change a beneficiary designation results in an unintended transfer of assets. The circuit court seemed to do what it thought was just by awarding the IRA to the estate, but the law did not support the decision. In the Supreme Court case, the couple had only been divorced for two months and it was likely that the ex-husband did not have an opportunity to change designations before dying in an auto accident. That did not matter. Thus it is important to change beneficiaries as soon as possible after a divorce becomes final.

Normally, withdrawing money from a 401(k) or an IRA is considered a taxable event that requires a party to pay income tax on the funds contributed as well as penalties. When accrued during marriage, retirement accounts are also considered marital property and are subject to equitable division in family court. The Internal Revenue Code recognizes that a Qualified Domestic Relations Order (“QDRO”) can divide funds in a 401(k) or similar retirement account. This allows the providers to roll funds into a retirement account for their spouse. While QDROs do not apply to Individual Retirement Accounts, a spouse can avoid a taxable event by rolling the divided funds into another qualified retirement account. Know that a spouse who converts any retirement funds to cash will be responsible for taxes and penalties for the account.

6 USCA § 408. Individual Retirement Accounts

§ 408(d)(6). Transfer of Account Incident to Divorce

The transfer of an individual’s interest in an individual retirement account or an individual retirement annuity to his spouse or former spouse under a divorce or separation instrument … is not to be considered a taxable transfer made by such individual notwithstanding any other provision of this subtitle, and such interest at the time of the transfer is to be treated as an individual retirement account of such spouse, and not of such individual. Thereafter such account or annuity for purposes of this subtitle is to be treated as maintained for the benefit of such spouse.

Qualified domestic relations orders (often called QDROs) create or recognize the existence of an alternate payee’s right to receive all or a portion of the benefits payable under a retirement plan. They are complex matters orders or decrees that require an attorney’s guidance in order to effectively transfer an interest in a qualified retirement plan. 401(K)’s, IRA’s, Pension Funds can be split should both parties agree and file a qualified domestic-relations order (QDRO), a legal document that directs pension-plan sponsors how to pay out the funds. These funds are tax free if rolled over into your individual retirement account.

A domestic relations order (DRO) is an order that grants alimony and/or property rights to the pension owner’s spouse, or child support under domestic relations law. For example, a property settlement could trigger the distribution of the retirement benefit plan to anyone who is not the plan participant. For the non-participant spouse to receive payment from the plan, the payment must be made in accordance with the qualified domestic relations order (QDRO). A DRO is qualified if it “(1) creates or recognizes the existence of an ultimate payee’s right to, or assigns to an alternate payee the right to receive benefits with respect to a participant under the plan, and (2) complies with other statutory requirements.” An alternate payee can be a spouse, a child, former spouse, or other dependent that is recognized by the QDRO as having a right to receive either a portion of or all of the benefits payable under the participant’s plan.

For a domestic relations order to become qualified, the plan administrator must join the suit as a party, and then decide if the DRO is qualified, and be permitted to represent the important interests. When determining if the DRO is qualified the plan administrator must determine if it fulfills several requirements. First, there must be a transfer of ownership. Thus, the order must “be one which ‘creates or recognizes the existence of an alternate payee’s right to…receive all or a portion of the benefits’ payable to the owner.” Second, the DRO must specify the names and addresses of each participant in the suit and the alternate payee; the amount that each alternate payee will receive; the number of payments that the order will be effective for; and the exact retirement plan the order governs. Third, DRO must specify the amount and duration of the payments. Fourth, when talking about retirement plans, the DRO must “provide that the court may not order the plan to provide to an alternate payee any type, form, or amount of benefit not normally available to the owning spouse. It also may not order the plan administrator to provide to one alternate payee any benefit already being paid to an alternate payee under another QDRO.”

Drafting a proper QDRO depends largely on the companies your clients have retirement accounts with. It is good practice to contact the companies where these accounts are located and ask if they have a sample QDRO they like their clients to use. Often this can save you and your client time and money. After you have drafted the QDRO but before you have a judge sign off on it, it is a good idea to send the QDRO to the plan administrator and see if it will be acceptable. The plan Administrator can then either approve the QDRO as is or make suggestions as to how to change the document. Following this extra step would prevent having to take multiple QDROs to the judge for their signature and it will often save you and your client time and money in the long run. Once the plan administrator informs you the QDRO will work, you can then proceed with obtaining a judge’s signature.

C. Updated Business and Estate Planning Documents

A will is a legal document that details what an individual would like done with his or her property and assets after death. If you have property you wish your cohabitant to receive after your death, you need to describe the property in your will and indicate your wish. Otherwise, if you don’t have a will to detail your wishes, your property will pass according to what are called intestate succession laws.

In most states, intestate succession statutes automatically distribute your property to your closest family members, i.e. your spouse, children, parents, etc. Without a will, your cohabitant won’t receive any of your estate unless he or she is successful in arguing that you had a financial or property-sharing arrangement. Such claims are often difficult to prove, particularly with the lack of any formal documents. Drafting a will is generally the best way to ensure your property is passed to whom you wish.

However, if you and your cohabitant are joint owners of the property, you may wish to consider a joint tenancy with a right of survivorship instead of a will. Joint tenancies give the cohabitants the ability to share the rights and responsibilities associated with the property during their lifetimes. Then, upon the death of one joint tenant, title to the property automatically passes to the other, without the need to go through the formal probate process a will requires. There are other benefits to a joint tenancy, such as tax savings, documentation of commitment, and the sharing of debt.

When you create a “power of attorney,” you have authorized another person to make decisions on your behalf, particularly decisions that may have a legal effect. A power of attorney is “durable” when it only becomes effective after you have become legally incompetent, i.e. unable to manage you own affairs. Durable powers of attorney are also called “living wills.”

There are generally two types of durable power of attorney, but this can vary depending upon the state you reside in. The first type, called the durable financial power of attorney, applies only to financial decisions. If you grant someone the durable financial power of attorney over your affairs, he or she will be able to manage your finances when you become unable, and must always act in your best interests. Second, there is a durable power of attorney for health care. While state regulations vary, the durable power of attorney for health care, otherwise known as a “medical directive,” allows you to name someone to direct your medical care if you become incapacitated.

If you would like your unmarried partner to manage your affairs should you become unable to manage them yourself, you should create both the durable power of attorney for health care and the durable financial power of attorney. If you have not completed these documents, financial and health care decision-making will typically pass to a member of your family when you become incapacitated.

Business Structures, https://www.irs.gov/businesses/small-businesses-self-employed/business-structures

Id.

Patricia Barrett, Divorce and the Closely-Held Business, http://www.divorcenet.com/states/texas/closely_held_business/.

Id.

https://www.sba.gov/blogs/exiting-or-dissolving-business-partnership-your-options-and-process-explained/.

Id.

Nicholas L. Bourdeau, Steps for Successful Investigation, The Determination of Income for Child Support, http://www.jameseducationcenter.com/articles/uncovering-hidden-assests/ (last visited Sept. 24, 2015).

Id.

FACTA Information for Individuals, IRS (Apr. 2, 2015), http://www.irs.gov/Businesses/Corporations/FATCA-Information-for-Individuals.

Gifts from Foreign Person, IRS (Feb. 11, 2015) http://www.irs.gov/Businesses/Gifts-from-Foreign-Person.

Form 3520-A, Annual Information Return of Foreign Trust with a U.S. Owner (Under Section 6048(b)), (Feb. 5, 2015), http://www.irs.gov/uac/About-Form-3520A.

Form 5471, Information Return of U.S. Persons with Respect to Certain Foreign Corporations, IRS (Feb. 19, 2015), http://www.irs.gov/uac/Form-5471,-Information-Return-of-U.S.-Persons-With-Respect-to-Certain-Foreign-Corporations.

Form 8621, Information Return by a Shareholder of a Passive Foreign Investment Company or Qualified Electing Fund, (Dec. 5, 2014), http://www.irs.gov/uac/Form-8621,-Return-by-a-Shareholder-of-a-Passive-Foreign-Investment-Company-or-Qualified-Electing-Fund.

Form 8865, Return of U.S. Persons with Respect to Certain Foreign Partnerships, (March 16, 2015), http://www.irs.gov/uac/Form-8865,-Return-of-U.S.-Persons-With-Respect-to-Certain-Foreign-Partnerships.

VALUATION AND SETTLEMENT OF DIVORCE CASES, WTS MA-CLE 8-1

Id.

No. E2009-01085-COA-R3-CV, 2010 WL 669244 (Tenn. Ct. App. Feb. 25, 2010).

Howard I. Gross, Steven W. Reed, Erika M. Gowan, Casey L. Higgs and Samuel M. Pollom, BGBC: 10 Crushing Questions to Ast a Business Valuation Expert, The Indiana Lawyer.com, (July 2, 2014), http://www.theindianalawyer.com/bgbc-10-crushing-questions-to-ask-a-business-valuation-expert/PARAMS/article/34516/.

Id.

Stange, Kirk, “Business Valuation Basics in Divorce”, Lawyers.com, 28 November, 2014.

361 S.W.3d 36 (Mo. Ct. App. E.D. 2011).

547 S.E.2d 110 (N.C. App. 2001).

849 P.2d 695 (Wash. Ct. App. 1993).

Scott Lockhart, Valuation Methods – The Income Approach, Simple 409A by Tower59, http://simple409a.com/the-income-approach/.

Id.

BPK&Z Financial Services, LLP, Valuation Basics – Approaches and Methods, BPKZ Certified Public Accountants, http://www.bpkz.com/valuation-basics-approaches-methods/.

Id.

Scott Lockhart, Valuation Methods – The Asset Approach, Simple 409A by Tower59, http://simple409a.com/the-asset-approach/.

Id.

99 A.L.R.5th 637 (Originally published in 2002).

2 Equit. Distrib. of Property, 3d § 6:19.

11 Ohio Forms Legal & Bus. § 27:62 (2014 ed.).

2 Advising the Elderly Client § 19:212.

2 Equit. Distrib. of Property, 3d § 6:19.

Findlaw, Wills and Durable Power of Attorney for Health Care (2015), http://family.findlaw.com/living-together/wills-and-durable-power-of-attorney-for-health-care.html (last visited Nov 12, 2015).

Id.

Id. I. Overview of Business Organization Structures

A sole proprietorship is a self-owned, unincorporated business. If a party is the owner of a sole proprietorship, then the business is dividable upon dissolution of marriage.

When conducting business valuation for divorce it is important to know what structure the business has in order to best value and divide the worth.

Division of the business: Will the business be able to continue operating if forced to liquidate assets?

A practicing divorce attorney will typically confront several typical interests in closely held corporations. These interests can be: (1) stock in the corporation; (2) membership in an LLC; (3) a partnership stake in a partnership; or (4) an ownership interest in a closely held family business.

II. The Valuation Process

· The equity in a home.

· IRAs or 401(k) plan assets – however, these should be calculated at their estimated after-tax value in order to compensate for the eventual tax on withdrawals.

· Securities outside of qualified plans may be the most desirable in offsetting the value of a business because there is little to no tax liability associated with these accounts.

Before you file any paperwork with your state, make sure you review your current business:

Have you or your partners completed all agreed duties?
What is the business worth? A third-party valuation can help you develop this figure. Once your partnership is dissolved you can typically expect each partner to assume business assets and liabilities based on percentage of ownership.
Review all leases, contracts, and loan agreements to see how the dissolution will affect them. For example, are you locked into a contract period regardless of your partnership status?

A. Tracking Down Hidden Assets: Savvy Tips and Tricks

· Does the OP own their own business/self-employed? This is an important factor because it is often easier and in some cases more likely for an individual that owns their own business or is self-employed to hide assets or maintain offshore accounts.

· Please describe the lifestyle you (the client) and OP live or lived. The OP’s lifestyle, or change in lifestyle, can also be an indicator of the possibility of hidden assets/accounts. For example, the OP may make expensive purchases (i.e., cars, homes, etc.) in an attempt to squander funds from hidden assets/accounts throughout the divorce process.

· What financial records/documents do you have in your possession and what accounts do/did you share with OP? Answering this question at the onset will be helpful once the discovery process begins so the attorney/paralegal will know what documents to request and where to look.

· Do you remain in contact the OP, and if not, do you know their home and work address? While this question may be basic, it is important to maintain a good idea of the OP’s whereabouts in case they attempt to leave town (not uncommon in cases involving hidden assets/accounts).

· FBAR (Foreign Bank Account Reporting ) Form : TD F 90-22.1 (Prior to 2014, FinCEN Form 114 (Present) are required for U.S. citizens who have foreign bank accounts;

· Form 8938-required under the Foreign Account Tax Compliance Act for individuals who own certain foreign financial accounts or assets with a total value of $75,000 or more at any time during the tax year.

· Form 3520-reporting requirement for U.S. individuals who receive a foreign gift or bequest valued at more than $100,000 from a foreign individual or estate.

· Form 3520-A-required reporting of a foreign trust with at least one U.S. owner to provide information such as the owners of the trust, the value of the owners’ interest, and the FMV of distributions (if any).

· Form 5471-Required for U.S. citizens and residents who are officers, directors, or shareholders in Certain Foreign Corporations (CFC).

· Form 8621-Required information return by a U.S. citizen or resident that is a shareholder of a Passive Foreign Investment Company (PFIC) or Qualified Electing Fund (QEF).

· Form 8865-Required return of U.S. persons with respect to Certain Foreign Partnerships.

· Stock Options & Restricted Stock

· Capital Loss Carryover

· Cemetery Plots

· Collections or Memorabilia

· Intellectual Property

· Retained Earnings

· Credit Card Reward Points

· Country Club, Golf Course and Other Memberships

All of these examples may easily get overlooked but potentially carry significant value. When valuing a business for divorce, it is important to be able to recognize and spot hidden assets.

· Focus on the future: Divorce can be an emotionally traumatizing time in a person’s life and dredging up the past will not help the client move forward to a resolution for all remaining issues in a divorce action. Directing discussions to what needs to be done in the future and what solutions can help resolve current problems is an effective way to keep the client moving forward towards settlement. Clients will often want to focus on past harms and past issues in the relationship which can lead to roadblocks on the way to settlement.

· Avoid sensitive issues: When tension and emotions are running high it is important for the attorney to direct their client away from discussions of sensitive issues. This is connected to avoiding discussions of the past but can also include discussion of which parent minor children would prefer to be with, whether one spouse moved out or was kicked out, and who is at fault for the divorce. Discussion of these topics can be counterproductive to establishing a settlement agreement that is satisfactory for the client and can extend the length of time until settlement.

· Focus on interests, not positions: One way to easily use this strategy is by asking your client what their concerns are. This can take the discussion away from who is right or wrong and towards what their specific concerns are that could be resolved through negotiation. For instance, your client is in a gridlock on settlement negotiation with his spouse because he does not want to move out but by asking him what his concerns are he voices that he does not want to lose contact with his children. Discussion of this concern can help direct the conversation in a meaningful way to determine if there is a compromise to be made where your client can move out of the marital home while still maintaining a close relationship with his children that is satisfactory to both parties.

III. Working with the Accountant/Appraiser

A. Sample Questions to Ask Business Valuation Experts on Examination

First, it is important to ask about the methodology, assumptions, procedures and how the opinion of value was determined. The following are some examples of potential other questions to ask.

· Have you personally sold a business or assisted a client in buying or selling a business in the same industry? How many have you sold?

· Do you know for certain if the amount you concluded to be the value of the business can be financed?

· Does your valuation comply with generally accepted accounting principles?

· Did you conduct a site visit? If so, when?

· From your previous valuations, has any value you determined ever been substantially changed in a court decision? Has the value stood up in court?

This question further discredits the expert by showing the judge or jury that the expert’s been wrong in the past.

· Have you ever been excluded as an expert? Has your testimony ever been excluded?

This is a direct hit at the expert’s credibility if he or she answers yes to this question.

· Who hired you and how many times have you worked for them?

· You advertise yourself as an expert for hire, is that correct?

· How much of your professional time is devoted to expert testimony?

IV. Standards of Value

The following are a few basic concepts and terms in forensic accounting:

Capitalization of Earnings: A method within the income approach whereby economic benefits for a representative single period are converted to value through division by a capitalization rate.

Capitalization Rate: Any divisor (usually expressed as a percentage) used to convert anticipated economic benefits of a single period of value.

Minority Discount: A discount for lack of control applicable to a minority interest.

Key Man Discount: Discount for loss of efficiency until someone is sufficiently trained to replace a key man.

Marketability Discount: Discounts for lack of marketability deal with the lack of liquidity of an ownership interest and how quickly and easily it can be converted into cash.

V. Methods and Approaches – Which to Use

A. Income Approach

B. Market Approach

· The Guideline Transaction Method involves searching databases for transactions in companies that are determined to be similar to the subject company. Ratios from these transactions (ex. price to discretionary earnings) are then applied to the subject company to estimate value.

· Guideline Company Method involves searching for comparable publicly-traded companies. If similar companies can be identified, certain ratios relative to these companies (ex. price to earnings) are then used as a basis for estimating the value of a subject company.

C. Asset Based Approach

Steps in employing the asset approach are:

· Start with the balance sheet – ideally this will be “as of” the same date as the valuation date

· Restate assets and liabilities to fair market value where necessary – this can be the most judgmental step in the asset approach

· Identify unrecorded assets and liabilities and what their impact will be on the valuation – these may be off-balance sheet commitments or assets that are not on the balance sheet.

VI. Deciphering Valuation Discounts

VII. What to Look for When Reviewing a Business Valuation

A. Tax Issues You and Your Clients Need to be Aware of

B. Planning for Retirement Benefits Attached to the Business

6 USCA § 408. Individual Retirement Accounts

§ 408(d)(6). Transfer of Account Incident to Divorce

C. Updated Business and Estate Planning Documents

Business Structures, https://www.irs.gov/businesses/small-businesses-self-employed/business-structures

Id.

Patricia Barrett, Divorce and the Closely-Held Business, http://www.divorcenet.com/states/texas/closely_held_business/.

Id.

https://www.sba.gov/blogs/exiting-or-dissolving-business-partnership-your-options-and-process-explained/.

Id.

Id.

FACTA Information for Individuals, IRS (Apr. 2, 2015), http://www.irs.gov/Businesses/Corporations/FATCA-Information-for-Individuals.

Gifts from Foreign Person, IRS (Feb. 11, 2015) http://www.irs.gov/Businesses/Gifts-from-Foreign-Person.

Form 3520-A, Annual Information Return of Foreign Trust with a U.S. Owner (Under Section 6048(b)), (Feb. 5, 2015), http://www.irs.gov/uac/About-Form-3520A.

VALUATION AND SETTLEMENT OF DIVORCE CASES, WTS MA-CLE 8-1

Id.

No. E2009-01085-COA-R3-CV, 2010 WL 669244 (Tenn. Ct. App. Feb. 25, 2010).

Id.

Stange, Kirk, “Business Valuation Basics in Divorce”, Lawyers.com, 28 November, 2014.

361 S.W.3d 36 (Mo. Ct. App. E.D. 2011).

547 S.E.2d 110 (N.C. App. 2001).

849 P.2d 695 (Wash. Ct. App. 1993).

Scott Lockhart, Valuation Methods – The Income Approach, Simple 409A by Tower59, http://simple409a.com/the-income-approach/.

Id.

BPK&Z Financial Services, LLP, Valuation Basics – Approaches and Methods, BPKZ Certified Public Accountants, http://www.bpkz.com/valuation-basics-approaches-methods/.

Id.

Scott Lockhart, Valuation Methods – The Asset Approach, Simple 409A by Tower59, http://simple409a.com/the-asset-approach/.

Id.

99 A.L.R.5th 637 (Originally published in 2002).

2 Equit. Distrib. of Property, 3d § 6:19.

11 Ohio Forms Legal & Bus. § 27:62 (2014 ed.).

2 Advising the Elderly Client § 19:212.

2 Equit. Distrib. of Property, 3d § 6:19.

Findlaw, Wills and Durable Power of Attorney for Health Care (2015), http://family.findlaw.com/living-together/wills-and-durable-power-of-attorney-for-health-care.html (last visited Nov 12, 2015).

Id.

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