Dividing a Business During a Divorce in Pennsylvania
Dividing a business during a divorce in Pennsylvania can bring about a certain set of specific challenges. If the business is a small and both parties are involved with the business, it many times can feel like you are going through a second divorce. Fortunately, there are efficient ways to go about handling this difficult situation and making your transition through this period easier. The goal of the split is to maintain current operation levels and reach a fair and equitable distribution of the company value.
One example to look at is the recent divorce that had Amazon right in the middle of it. The divorce of Jeff and Mackenzie Bezos shows how a divorce can be equitable, because it allowed her to maintain her current level of living even if the company value is not split 50/50. Her $32 Billion dollar settlement was an equitable distribution of the company’s valuation and it left the company with enough operating assets to maintain operations.
It is important to determine the value of a business when dividing it during a divorce. When it comes to determining value of a business typically a third party can be hired to investigate and determine this value, this party is referred to as the business valuator. There are two types of opinions a business valuator can use, a calculation of value and a business valuation.
Calculation of Value
A calculation of value is a much simpler and quicker way to determine business value. This can be used when both parties are working together and agreeing on numbers and valuations. This is still a legitimate method and holds its value because reasonable numbers are still used. If both parties cannot agree or are amicable towards working toward the valuation, the much more complex and in-depth method will be used, the business valuation. This method, since it is far more in depth is also far more expensive.
When pursuing the business valuation method there are three ways to approach a true business valuation. They are the income approach, the market approach, and the asset approach. The first two, the income and market approach, typically yield similar numbers, with some exceptions, while the asset approach is typically the lowest of the three..
The income approach looks at the businesses present value and future earnings or cash flow. The value of the company is derived from earnings produced and projected earnings. This valuation is primarily based on the income statement on the businesses tax return.
The market approach uses industry standards to attribute a value to a business based on the value assigned by the market in comparable situations. Essentially this is like how a realtor values a home by looking at the market in the area and attributing similar houses within a similar neighborhood to attribute a value to the home. The valuator looks at the industry of the business to see what similarly situated businesses are valued at.
The asset approach is when valuators look at all the assets the company owns. This approach takes the value of all tangible and intangible assets. Tangible assets are things the company owns such as cash, inventory, investments, property, equipment, vehicles, and anything of a physical, concrete nature. Intangible assets are anything that are not physical items such as patents and copyrights.
From here a business valuator will look at the three different numbers these approaches yield and can give an estimate on what the business is worth. The reason one approach cannot be used without the others is because if you simply look at assets for example if you have a business the operates out of rented space and is simply a small number of people with maybe two computers and a couple of desks the value of the assets of that company could be far lower than the amount of money they are earning from performance.
So now that we have discussed valuating a business, we need to look at how to split it up during a divorce. There are many different scenarios of how a business can be split up and they can get very complex, but for simplicity the scenario we want to look at is when we have an owner and one spouse who is not involved in the business. If the valuation for the business is $500,000 and the agreement is a 50/50 split, then the owner is responsible to pay out their spouse $250,000. The problem then arises when the owner doesn’t have $250,000 in cash to pay out the settlement. That valuation comes from many different things within the business, like previously discussed.
Splitting the Business Value
One thing your lawyer is then responsible for is to look for some way to balance out this payout that will not cost your business operation capacity. One offset that can typically be found is within your home equity. If the home is worth $500,000, so long as the mortgage was paid off, then the business owner has half an interest in the home and therefore has $250,000 of interest in the house. Rather than splitting both the business and the home you can come to an agreement that the business owner keeps the business and the spouse keeps the home.
There are exceptions to when this is favorable to one party or another. You must worry about capital gains taxes when coming to an agreement. If the owner of the business were to sell his business he would be getting taxed on that, while the spouse who kept the home would be responsible for the normal real estate taxes they have already been paying on the home while living there.
Alternatively, if the owner of the business offers $250,000 in retirement funds, then this is unfavorable to the person receiving the funds because they cannot access them, at least tax free, until retirement. Therefore, the spouse who owns the business keeps the capital value of the business and is earning income, while the spouse who received retirement funds cannot access them for say another 20 years.
Payout Over Time
Another issue is if there is a payout over time, the person who owns the business takes on a risk of if the company remains profitable. If you agree to a payout and something occurs, and the business isn’t making money anymore you cannot use bankruptcy to get out of a divorce agreement. Once the court locks you into that agreement its your responsibility to pay.
Another option to look at is financing. If you can secure financing for this you are much safer, because if you get sued by the bank for that money then filing for bankruptcy can help you get out of or around not being able to pay the bank back, while if you are making payments directly to a spouse through business profits then you run a greater risk if the business goes through a rough time and you are still responsible to make those payments.
That is where a good lawyer comes into effect. If you are going through a divorce or are considering going through a divorce, splitting a business can be complicated and dangerous if you attempt it alone. In order to make sure you do what is best for your specific scenario contact The Law Offices of Michael Kuldiner, P.C. and we will help you navigate through this divorce pursuant to Pennsylvania law.