Divorce Business Valuations and How They Play Out in King County
You spent your lifetime building this business. You put in your own capital and years of sweat equity. You took risks when people told you to get a job and now you are faced with possibly losing some or all of your business because you are getting a divorce. Commonly there are two questions that we see regarding small businesses. Both questions are really the same question, just framed a little different.
1). The first question is, is my wife going to take my business (even if she never worked a day in her life)?
2). The second question is, how much of my business is my wife going to get (even if she never worked a day in her life)?
The questions can be framed with or without the context of whether or not the wife is worthy of receiving a share of the business. Both questions are usually framed in some sort of context notating what little involvement the wife had in the business.
Do you have a prenup?
In answering that question, we must first address a threshold question: did you sign a prenup? If the answer to the prenup question is “Yes”, then you stop here and go read the prenup.
But, beware, just because the prenup says she gets nothing doesn’t mean it will be enforced. To answer that question, you’ll have to set a consultation and bring the prenup with you. Assuming you don’t have a prenup, there are two moving targets to keep in mind.
Length of Marriage
Exactly how long you have been married, or length of marriage, is the first moving target. The length of marriage determines the portion of your business that is subject to community property. This does not mean that she will get that portion from you. It just means that it is the portion that the marriage gets to slice up between the divorcing couple.
Usually, your wife gets ½ of that percentage. In other words, your wife will take ½ of the community portion of your business from you. Again, this number always gets worse for you over time.
The second moving target is the actual value of the business. How much is the business worth? In the real world, it’s much more cut and dry. Businesses are worth what someone else will pay for them. That’s it, and not a penny more.
In the context of a divorce case, the real world value of a business is not relevant. In other words, it simply doesn’t matter. Even if you were selling the business, it wouldn’t matter because your wife would just get her slice, however small it may be. The real problem is when you aren’t selling the business.
What if I’m keeping my business?
It’s important to understand that Judges don’t know how to run a business. They don’t know what covering payroll means. Many of them don’t even know what a B&O tax is. They have no idea about the risk you take every day to run your business. They don’t understand that it sometimes requires babysitting of employees and they have no clue that one single change in the regulatory environment for your business could radically reduce the value of it immediately.
For the reasons mentioned previously, this is exactly why many judges tend to embrace some form of earnings based formula that either takes your gross income before interest and taxes (EBIT) or takes your gross income before interest, taxes, depreciation, and amortization (EMBITDA). Many evaluators then apply a rudimentary profit multiplier (often it’s 3 to 5) to the proceeding number to determine the value of the business.
If you think that the proceeding number isn’t entirely fair, you’re right. It isn’t. It highlights everything that is wrong with business valuations under divorce because it manages to both grossly oversimplify and under simplify the true value of your business at the same time.
For some professional based businesses, a net earnings times multiplier calculation can make sense, but it can also inflate the value of goodwill as it applies to the true business value. Location of the business is also critically important. You’ll want your evaluator to understand the localities of the market, and not apply Seattle generalities to a business in Bellevue, Everett, or Tacoma.
Deciding if you need help
There are a multitude of business valuation methods. Certain divorce business valuations such as the earnings multiplier formula tend to be favored in King County, while other divorce business valuations tend to be favored in Snohomish County. If you understand the valuation being used and generally agree with the findings in your divorce business evaluation, then you’re in a good position.
If don’t trust the divorce business valuations used in your case or if your lawyer doesn’t seem to understand business and how business work, you may want to get another look. When these issues get to trial, a skilled attorney can use cross-examination to really confuse the judge as to what the true business value of a business really is. You don’t want to be on the wrong side of a distorted business evaluation because your lawyer doesn’t understand them either.
To arrange a consultation with one of our attorneys, all of whom have prior experience running their own small business, contact our office at 206-625-9800.