Divorce is tough. Establishing timeshare with the kids, determining support paid and dividing assets are all daunting tasks. During this process, one must be well informed and prepared. Knowledge is key to your success as a divorce litigant. Quite often litigants are ill-informed and kept in the dark by their Family Law attorney. This is a mistake! I tell my clients all the time “You’re the Captain of the ship and I am the crew.” In order to avoid disaster, the Captain must always be well informed!
One of the major areas I find litigants ill-informed is the division of assets, particularly the division of the business. Putting aside the emotional connections to such an asset, a party must be aware of the realities when dealing with this issue.
A common misconception held by self-represented litigants is that a sole proprietorship, i.e. One dentist professional practice, is not divisible during a divorce proceeding. These individuals are in for a rude awakening when they discover that their one-man-operation is not only divisible but subject to all of the same community property laws as other assets.
Now I know what you’re thinking, “The business is me and I am the business… I can’t sell it, it would be worth nothing without me!” This is often the argument made by people engaged in professional practice, i.e. Dentist, doctor, accountant and or talent agent. Unfortunately for these people, the actual ability to sell or transfer the business is not a dispositive fact for the court. Generally, businesses are transferable in theory. This theoretical transferability creates value in it.
If established during the marriage, a business, and its respective value can be treated as a community property asset. In a California divorce proceeding, such assets are usually divided 50/50 between the parties. This is sometimes challenging when dealing with professional practice, especially if a special license or training is required to operate it i.e. Medical doctor, dentist. Consequently, in order to effectuate a fair division of the estate, the business is usually granted to the operator-spouse. The operator-spouse then effectuates payment to the other spouse. Determining the amount of payment is based on the value of the business. Now, this is where it gets interesting!
Business valuation can be best described as an exercise in creative accounting. In determining business value, the California court’s generally utilized an excess earnings method. This method involves a two-step process. First, the court’s look to the tangible assets of the business. Assets can be anything from furniture, to automobiles and even accounts receivables that have yet to be collected. Discounts can be given for various factors i.e. Depreciation, collectability of an account receivable. Second, the court looks to the goodwill of the business. Goodwill generally involves an analysis of business earnings (salary + perquisites) multiplied by a capitalization rate. The capitalization rate usually depends on the type of business and its stability, or lack thereof. Once the net asset and goodwill figures are determined, the courts usually end up adding the two figures.
Now it goes without saying that a great deal of opinions goes into establishing the net asset and business goodwill. Areas of debate usually involve the value of an assets, liabilities associated with the business and overall health of the business. Goodwill determination can be heavily impacted by the capitalization rate. This rate is usually based on an opinion generated by an accountant.
Notwithstanding the above, California case law has held that only a business can have goodwill. If one is not engaged in a business then there can be no goodwill to divide. In the 2005 California case of McTiernan vs. Dubrow, husband, a famous Hollywood director (Die Hard, The Hunt For Red October) successfully challenged a lower court’s ruling regarding the nature of his activities as a movie director. Once he was able to demonstrate that his activities were not akin to a business, the court of appeals held that goodwill could not possibly be attributed to his activities. Consequently, there was nothing to divide! This is an intense fact-based analysis. If you wish to prevail using a McTiernan argument, be ready to put on your evidence.
So, what now? There is no perfect answer. However, what is obvious is that business valuation can be difficult. Understanding the intricacies and potential pitfalls is imperative. Bottom line, hire an experienced attorney and forensic accountant familiar with YOUR type of business. This may end up saving you thousands of dollars in the long-run. Here are some pointers, (a) keep all major financial records from the time of marriage i.e. Tax returns, general ledgers (b) keep all major financial records from the time of separation i.e. Tax returns, general ledgers (c) make sure your finances are on the up and up, don’t run personal expenses through your business and (d) consider hiring a Certified Family Law Specialist with experience in handling business valuation issues.
Sincerely,
Patrick Baghdaserians, CFLS
Firm Principal, Baghdaserians Law Group
790 East Colorado Blvd., 9th Floor
Pasadena, CA 91101
