Getting a Divorce? Protect Yourself with a Professional Valuation

No one enters into a marriage expecting it to end in divorce, but unfortunately, statistics suggest that it’s often the outcome. When a business owner gets divorced, the stakes are often higher, and the divorce process becomes much more complex when the marital estate includes the ownership of a company. 

Below, we’ll highlight a real-world case that shows just how problematic valuation in divorce can be and how critical it is to bring in an outside expert to help you, as the business owner, get what you deserve out of the asset. 

Related: When to Hire an Appraiser During a Divorce

Divorce Valuations are Complicated

Divorce cases involving business ownership are a complex beast, and your jurisdiction dramatically impacts how a company, including both tangible and intangible assets, is valued in a divorce proceeding, given that the business is almost always the most significant asset in the marital estate. Matters related to the valuation of that asset can be highly contentious. The fact that the asset is “illiquid” – i.e., cannot easily and quickly be sold and turned into cash, only exacerbates the issue. 

The Importance of a 3rd Party Valuation

Divorce cases can be either contested or collaborative. Contested divorces occur when spouses cannot agree on critical issues that must be resolved before finalizing. In contested business divorces, each side is an entirely separate entity, and any differences are resolved in mediation and, if needed, in a courtroom. In a collaborative environment, both parties agree to retain an expert jointly. By having a single expert working on behalf of both parties, the shared expert can help resolve valuation issues without the drama of facing off against the opposing side. 

It’s best practice to bring in a reputable third-party valuation firm (like Quantive) to assess value in both contested and collaborative scenarios. However, business owners occasionally question the need for a certified valuation and think they could just perform the appraisal themselves.

Before you DIY your valuation, consider the following:

• How much valuation experience do you actually have? 
• Is this the best use of your time?
• How do you know if you got it right?

So what’s the worst that can happen? This recent case exemplifies the risks of a party acting as its expert for a valuation in a divorce case. It emphasizes the significance of how the standard of review affects an appellate panel’s review of the trial court decision. Let’s dig in!

Case Background: 

During the trial, the husband provided a valuation expert who used a capitalization of earnings approach to value his practice at around $2,000,000 as of June 2017. The expert mainly adjusted the 2015, 2016, and 2017 earnings to account for excess shareholder compensation. The expert deducted 21% from this valuation to account for the wife’s professional goodwill and concluded that the husband was entitled to $518,500.

During the trial, Wife testified that she believed the business was worth $662,452 and used a methodology that involved deducting business debt from 60% of average gross receipts. (source: Kwak v. Bozarth, 2023 Mass. App. Unpub. LEXIS 179; 102 Mass. App. Ct. 1116; 2023 WL 2817904 (Mass. App. April 7, 2023))

The trial court dismissed the wife’s calculation, stating it was not a recognized business valuation method. Instead, the court accepted the husband’s expert’s analysis with a single adjustment. The wife appealed this decision, arguing that the court should not have accepted the expert’s normalization adjustments of shareholder compensation and the seemingly arbitrary professional goodwill adjustment.

Appellate Court Findings:

The valuation expert concluded that the company paid Wife more than the market compensation in 2015, 2016, and 2017, based on publicly available web data for dentist salaries in their area. The professional admitted that the data used for the report was not specific enough to differentiate between the pay of a general dentist and that of a prosthodontist. Additionally, he failed to find any specific compensation information for prosthodontists from sources such as professional associations or the US Bureau of Labor Statistics.

During the appeal trial, the wife stated that her compensation was not excessive because the standard practice in the industry was to pay prosthodontists up to 50% of their collections. However, her appeal was denied anyway. Due to the fact that she did not have a professional valuation performed, the appellate court found that the trial court was not obligated to accept her testimony as credible, even if the husband did not present any evidence to challenge it. Why? A straightforward reason only:

The value of a business is a factual issue. In the US, the court of appeals does not receive additional evidence or hear witnesses. The court of appeals may review the factual findings made by the trial court or agency but generally may overturn a decision on factual grounds only if the findings were “clearly erroneous.” (Source: United States Courts) Even though the husband’s valuation expert acknowledged that the data he used to calculate value did not differentiate between dentist and prosthodontist salaries, the fact that the wife did not have any valuation performed by an expert still put the husband ahead of the curve. If you’re going to court, the importance of a valuation report compiled by a third-party expert cannot be overstated.

Discounts Matter in a Divorce

No two valuations are identical, and the need for an expert valuation becomes even more apparent in the context of a divorce. Divorce is an excellent example of how the purpose of a valuation can affect its value. For instance, if we assume that we are valuing a minority interest (generally 50% or less ownership interest) lacking elements of control and liquidity, we, as valuation analysts, would typically consider applying a Discount for Lack of Control and/or a Discount for Lack of Marketability. This could result in a discount from the pro-rata share of the business, ranging anywhere from 20-50%. (The applicability of discounts varies state to state- something your attorney and valuation specialist will work together to resolve.) So not only does having a professional valuation improve your chances of the calculated value holding up in court, but it also allows your valuation analyst to analyze your business in the context of the triggering event, in this case–divorce, to arrive at a value that works best for your purposes.

Divorce Valuations Summed Up:

Suppose you need to know the actual value of something, such as for a sale, buy-sell agreement, acquisition, or divorce. In that case, it is recommended that you have an actual valuation conducted by a qualified professional. While estimates can be helpful in informal scenarios, a certified valuation is necessary for legal and formal purposes.

Since 2003, Quantive has performed over 3,000 business valuations. Contact our valuation specialists for a no-cost consultation today.