The value of your business or your spouse’s business can be one of the most valuable assets of the marital estate. The value often exceeds that of the marital home, outside investments or even retirement plans.
Since the business is not publicly traded, there is not a quick, convenient way to determine the current value of the business.
Typically, an independent business appraiser is hired to analyze the business and determine the “fair market value”. In a litigation environment, two appraisers are often hired to value the business. In a collaborative divorce, one appraiser is hired by both parties often saving duplicative costs and effort.
There are three general approaches that are used to value a business. These approaches are the asset approach, the income approach and the market approach.
In a collaborative divorce, one appraiser is hired by both parties often saving duplicative costs and effort.
The Asset Approach
The asset approach focuses on the net asset value of the business. The net asset value method is often used. When using this method, the historical costs of the assets are restated to fair market value. Liabilities are also restated to fair market value. The value of the business is calculated by subtracting the stated or estimated fair market values of the liabilities from the fair market value of the underlying tangible assets.
The Income Approach
The income approach focuses on the cash flow of the business. Under the income approach, three methods of valuation are commonly considered: capitalization of earnings, capitalization of excess earnings and discounted cash flow. A capitalization of earnings method is most suitable when an entity’s future earnings are expected to increase at a stable rate. The discounted cash flow method is most suitable when a business’ future performance is expected to vary.
The Market Approach
Under the market approach, three methods of valuation may generally be considered: guideline public company method, guideline merged and acquired company method, and rules of thumb. The guideline public company method is usually used to value larger privately-owned companies. Current stock market multiples are applied to the privately-owned company data to determine value. The guideline merged and acquired company method utilizes data from actual sales of privately-owned companies. Rules of thumb are very generic in nature and only serve as a quick approximation of value. Rules of thumb vary greatly by industry and should be used with caution.
The business appraiser will use their experience and professional judgment when determining which approaches and methods are appropriate to use when valuing your business.
Regardless of the methods used, the appraiser will conduct a thorough review of the financial data, interview management and perform industry research.
Although valuing a privately-owned business is a complex process, the appraisal is a key component to bringing the collaborative divorce to a successful conclusion.
