Business Interests

Business interests represent ownership stakes in a business entity and may be significant assets to be addressed in a divorce. These can be some of the most complicated assets to value and strong emotional ties may make business interests a challenge to address in divorce.  It is important to first gain a full understanding of the business interests and their value.  Then the parties need to decide how to handle the business – whether one or both of the spouses intend to keep it moving forward – and then determine the corresponding financial agreements. Depending on the complexity of the business interests, it may make sense to engage a professional, such as an attorney, business valuator or financial advisor.

Types of Business Interests

There are various types of business ownerships.  Technically, owning stock in a company could be considered a business asset. You can learn about stock owned in a publicly traded company in the Investment Accounts module. Here are the most common other business interests that come up in divorce and some of the considerations regarding valuation:

Business Ownership: This refers to an individual's or couple’s ownership stake in a business entity. It could be sole ownership, where one person has complete control and responsibility for the business, or joint ownership, where multiple individuals share ownership rights and responsibilities.  The business may be held in a business structure such as a sole proprietorship, limited liability company, or corporation. This business ownership is common for an entrepreneur who created a new business from nothing or bought an established business and has taken over management.

Partnership or Ownership Interest in a Firm: Partnership interest denotes ownership in a business entity where two or more individuals share ownership, management, and profits. It could also refer to ownership interest in a corporation or LLC (Limited Liability Company), where an individual holds shares or membership interests. The ownership may be active, where the owner is actively involved in the day-to-day management of the company or passive, where the owner isn’t engaged in the business in a substantive manner. Certain professional firms, like law firms or accounting companies, may provide partnership opportunities for employees to buy into the partnership for an ownership interest in the company.  

Business Entity for Self-Employment: This pertains to a business established and operated by an individual for their own benefit and livelihood. It could include sole proprietorships, where one person owns and operates the business, or single-member LLCs where a single individual is both owner and operator.  This company may have little or no value but provides tax benefits for a self-employed individual.

Business Investment: This encompasses investments made by an individual in a business venture with the expectation of receiving returns. It could involve purchasing shares in a publicly traded company, investing in a startup, or providing capital to an existing business in exchange for ownership or profit-sharing. These business interests sometimes have capital calls, where the company requests additional investment funds from some or all of the current investors.

Real Estate Investment: Real estate investment refers to the ownership or partial ownership of property with the intention of generating income and/or appreciation over time. This could include residential or commercial properties, rental properties, vacant land, or real estate investment trusts (REITs).  There are complications in valuing these types of business interests because of the speculative nature of real estate valuations and the potential for rental cash flow on a monthly basis.

Board Membership: Serving on the board of directors of a company or organization may be considered in divorce if there is any inherent value in the position. Board members typically have fiduciary duties to act in the best interests of the company and its shareholders.  Board members may or may not have an ownership interest in the company.  Compensation for board membership may include fees, stock options, or other forms of payment. This type of business interest may impact both property division and cash flow depending on the specifics of the position.

First: Gather Facts

In a divorce, each of these business interests may be subject to evaluation and division as part of the marital assets. Proper assessment often involves determining the value of the interest, considering factors such as income generated, market value, liabilities, and future potential. Additionally, legal counsel and financial experts may be consulted to ensure a fair and equitable distribution based on the specific circumstances of the divorce proceedings.

Gather Relevant Information

In order to gain an understanding of the details and potential value of these business interests, you should gather and review all related documentation.  You can typically find agreements or ownership policies and procedures to have an understanding of the business interest.  It may be useful to review the business's financial records, including balance sheets, income statements, and tax returns, to begin to understand the value of the business interests. Additionally, legal considerations such as shareholder agreements, operating agreements, and any restrictions on the transfer of ownership should be thoroughly reviewed to ensure compliance with applicable laws and regulations.  Some business interests may be easily shared or divided in divorce while others may have prohibitions against co-ownership or transferring the business ownership to another.  If you cannot find any written policies or documentation, you may want to reach out to the business owner or management (if not solely owned by one spouse) to confirm the possible options for the business in divorce.

Establish Business Value

Once you have identified the business interest and reviewed all documentation, the next step is to establish a business value.  Valuing business interests in divorce can be complex and may require the expertise of a qualified business valuation expert. Business valuation models are essential tools used to determine the worth of a business, providing insight into its financial health and potential. Several methods may be employed to determine the value of a business.

• Asset-Based Approach: Also known as Book Value Method, calculates the value of a business by subtracting its liabilities from its assets, often as recorded on the balance sheet of the company. This valuation approach uses the business's assets, such as equipment, inventory, and intellectual property, to establish a value. This approach assumes the value of the business is the equivalent of selling all its assets and paying off all debts. The book value may not reflect the true market value of some assets, like real estate or equipment whose values may have appreciated or depreciated over time which is often not reflected on the balance sheet. Adjustments may be needed to the book value of these assets to reflect their accurate fair market value. Intangible assets, such as goodwill or intellectual property, are also considered in this method which may also be difficult to value.
• Income-Based Approach: Estimating the business's value based on its income-generating potential, often using methods like discounted cash flow analysis (DCF) or capitalization of earnings. DCF estimates the present value of a business's future cash flows, taking into account factors such as revenue projections, operating expenses, capital expenditures, and the time value of money. This method requires making assumptions about future cash flows and discount rates and it is often used for businesses with predictable cash flow patterns. The capitalization of earnings method calculates the value of a business by dividing its expected earnings by a capitalization rate, which reflects the risk associated with the business and the expected return on investment. The earnings used may be historical or projected and the capitalization rate is often derived from comparable companies or industry benchmarks.  There is also an excess earnings method that is particularly suitable for valuing service-based businesses.  This method estimates the value of a business by separating its tangible assets' return from its intangible assets' return. It calculates the value of the business's excess earnings, which are the earnings above a fair return on its tangible assets, and then capitalizes these excess earnings to determine the overall business value.
• Market-Based Approach: Comparing the business to similar companies that have been valued and/or sold recently, considering factors such as revenue, profits, and industry trends. This method involves comparing the business being valued to similar companies that have been sold recently or are publicly traded. Key financial metrics such as revenue, earnings multiples, and market capitalization are used to determine the valuation multiples, which are then applied to the subject company's financial data to estimate its value.  Similarly, this valuation may be based on the transaction multiples observed in comparable sales of businesses, adjusted for differences in size, growth prospects, and other relevant factors.

Selecting the most appropriate valuation model depends on various factors, including the nature of the business, its industry, its growth prospects, the availability of data, and the purpose of the valuation. Often, a combination of valuation methods is used to arrive at a more accurate estimate of the business's value. Working with qualified business valuation professionals who have a deep understanding of valuation principles and industry dynamics can enhance the accuracy and reliability of the business valuation.

Second: Understand the Law

Sell or Keep

Once the value of the business interest is determined, then you must consider the option for handling the business in the divorce.  First, it’s important to decide if the business interest will be sold or if it will be kept moving forward.   Selling the business interest and dividing the proceeds between the spouses in an agreed-upon manner is a straightforward option if the parties agree to sell the interest and there is a market or potential buyer for it.  

Co-Own or Buy-Out

Alternatively, if the business interest is going to be kept after the divorce, you will need to decide if one of you will keep it or you will co-own the interest moving forward. Both options present potential challenges.  If one of you is going to keep the business then the value must be agreed upon and a buy-out negotiated.   Depending on the law in your jurisdiction, business interests are typically treated like all other assets and divided in an equitable manner in the overall property division.  So if one spouse is maintaining the business interest after the divorce, they will typically compensate the other spouse with other marital assets of equivalent value. Or you may negotiate a buy-out over time either through a lump-sum payment or installment payments over time. The unique nature of each business asset may lead to unique buy-out agreements.

If agreed, spouses may also continue to co-own a business interest post-divorce.  This could mean you jointly operate the business post-divorce, either as partners or shareholders.  It might also result in continuing to hold a passive business interest (like an investment in a start-up) and waiting to share any potential income from the business interest later.  You will want to outline the details of any co-ownership agreement on business interests to avoid conflict later.  Specifically, you will want to outline the percentage of ownership each spouse will have post divorce, how any additional work in the business will be considered in the future sharing of benefit, and how any additional investment will be shared if needed.  While there are complications involved in co-owning a business interest after divorce, many couples can navigate those challenges to allow for both to share in the reward and risks associated with business interests.

Non-Marital or Separate Interest

If there is a non-marital or separate interest in the business interest, it should be identified and then addressed in the agreements reached.  This non-marital or separate interest often exists if the business was started prior to marriage or if a business interest was obtained with a gift or inheritance received during the marriage.  If the business interest began with a non-marital asset but grew over the course of the marriage through work by one or both spouses or if additional investments were made during the marriage, it may be a hybrid asset with some portion of the business interest being separate/non-marital and the remainder being joint/marital property.

Analysis with Cash Flow

Keep in mind that some business have both fair market value and should be addressed in the property division analysis and also provide ongoing income moving forward to help with cash flow. This can be a complicated element of business interests to work through.  It is often considered unfair to use an income-based valuation method on a business, which essentially accounts for the ongoing income stream in reaching a value for buy-out and then also use that income stream in the cash flow analysis. This could be seen as double counting the asset and have the business owner spouse pay for both the property division buy out and share income in cash flow.  Be aware of this potential challenge and work with an expert if you need to separate out the inherent business value and the ongoing income stream.

It is also important to note that some business don’t have value and may be running at a deficit or only have debt associated with it.  These interests are treated similarly to other debts during divorce and should be valued and analyzed in this process.  All business interests need to be disclosed and addressed in the divorce whether they have high value or none at all. By making sure both spouses have a clear understanding of the nature and value of the business interest, you can ensure that the interests of both spouses are protected and that a satisfactory resolution is reached. The more complex the business assets are, the more likely you should consult with an expert on this matter to make sure you are protected in the final resolutions.