The disposition of business assets in a Texas divorce

Within the property division process, the Texas family law distinguishes community property from separate property. The analysis is necessary for the purpose of allocating property to parties pursuant to a divorce. This is because community property is treated different from separate property. Assuming there is not a

property division agreement

, under Texas law, all jointly held community property is divided by the family law court and distributed to divorcing spouses. However, some property can be variable and difficult to characterize. This is often the case when one spouse to an ending marriage holds ownership in a business.

Whether one is a company owner or spouse of the business owner, he or she should integrate corporate law principles into the assessment of the property division process. One could be entitled to a fair share of business-related community property; however, this could be overlooked if the assets are disguised in what appears to be a separate business. If this is the case, one spouse could walk away with the businesses’ assets, which were supposed to be divided equitably in the divorce within the community estate.

Property division of business assets

A corporation is generally considered its own entity, meaning it is characterized as separate property. In most divorce cases, a spouse’s interest in a corporation is subject to division by a family law court; the remainder of the corporate property is off limits and not pushed into the community property portion. However, there is an exception to this rule when an “alter ego” exists.

The “alter ego”

If a business is an “alter ego” of a divorcing spouse, courts may transfer assets out of the separate company and divide them among litigants in the property division process. A business is an alter ego of spouse if the corporate veil of the business is “pierced,” changing the disposition of company property. The corporate veil will be “pierced” if a family law court finds that there is essentially no distinction between the business and a divorcing spouse (as if the business no longer exists and the two are one in the same). Furthermore, the divorcing spouse will be considered the alter ego of the company if a spouse’s use of the business damaged the community estate (the couple’s marital assets) beyond repair to the point where it would be fraudulent or unfair to separate the spouse from the entity. This might happen, for example, when a personal business completely funds a family’s income.

When the property division process begins, courts will look at all jointly held property. It is important to ensure that all assets subject to property division are included in the community property estate. Likewise, it is just as important to protect separate business assets, if necessary. To make sure that your property division resolution is equitable, retain the assistance of a qualified family law attorney in your area. A lawyer can explain business principles and how they apply to your particular situation.

When Business Owners Divorce: The Importance of Business Valuations

 

A few years back, many individuals found themselves searching for new careers after the economy plummeted. Some took jobs similar to those they left behind while others chose to make their own paths and open small businesses.

Both the Wall Street Journal and Forbes report that some entrepreneurial businessmen and women with new startups were recently hiring at “a red hot pace.” In fact, Forbes notes hiring for entrepreneurial companies rose over 13 percent compared to last year, a much stronger increase than that of established companies, which reported hiring growth levels at 3 percent.

As these new businesses thrive, owners may have to address other concerns. Although there is no evidence to support the notion that divorce rates are higher for business owners than other couples, it is hard to ignore the high level of stress and long hours required to run a successful business. Unfortunately, these factors can play roles in the breakdown of a marriage.

This can lead owners and their spouses to wonder: what happens to the business in a divorce?

Please click here to read the article in its entirety

 

Divorce and the Small Business Owner

Deborah L. Cohen writes for Reuters about Divorce and the impact on small businesses.  Ms. Cohen points out that when small business owners go through a divorce, their attention is distracted from their business, causing financial impact on the business which may already be distressed due to the downturn in the economy. Cohen points business owners to four ways to protect themselves: 1) a will, 2) a premarital agreement, 3) buy/sell agreement, and 4)  an entity to hold the business in trust.

Although Ms. Cohen's points are valid -- divorce does have a significant impact upon small businesses, I disagree with her points for protection.  To me, the biggest impact of a divorce on a small business is the distraction the divorce and personal problems in general cause on the business owner.  When a business owner's focus is diverted, the business can dwindle.  To counteract this problem, the business owner should work very hard to find an attorney to handle his divorce who has experience with small businesses and who he feels comfortable with.  That way, the business owner can focus on running his business and allow the divorce lawyer to focus on the divorce as much as possible. 

Although it is a good idea for anyone to have a will, a will has no effect in a divorce.   A buy/sell agreement is also of questionable effect in a divorce in Texas since such agreements usually only bind the business owners and not the spouses.  Such agreements, to be enforceable, would need to comply with the rules regarding post-marital agreements.  LIkewise, placing a business into a trust could be frowned upon in divorce court and considered fraudulent to the marital estate by depriving the marital estate of a very valuable asset.

Divorce Business Valuation Article

 

Proper Evaluation of "Goodwill" of a Business During Divorce
Posted by Michelle May O’Neil on May 23, 2011

 

This article deals with people who own a service business and are the focal point in their business. In most states the assets owned by an individual going through a divorce must be valued. This includes a business that one spouse may own. The value of the business may include both tangible assets and intangible assets. The majority of the value of the intangible assets may be related to "goodwill". Goodwill is defined as the characteristics of a business or individual that cause customers to return to that business or person.

 

In many cases, the value of the business or practice is determined based on the earning stream of the business. The concern to the spouse who owns the business, and who also has a spousal support obligation is that the earning stream used to value the business is also used to pay the spousal support obligation. This is what is called the "Double Dip Theory".

In many states, this situation is avoided when the portion of the business that is related to "Personal Goodwill" is excluded from the value of the business, or "Enterprise Goodwill". Thus, it is very important to identify and differentiate Personal Goodwill from Enterprise Goodwill.

 

These two types of goodwill can be defined as follows:

  • Enterprise Goodwill is associated with the entity itself. It takes into consideration issues such as location, qualified workforce, required licenses, name, etc. The key is that the value of the business is separate from the individual owner.
  • Personal Goodwill is associated with the individual. It takes into consideration the individual's age, health, personal reputation, training and effort. Customers return to the business because of the individual. The value of the business does not exist absent the individual.

The key is whether the Goodwill can be sold or transferred independent of the individual. Generally, Enterprise Goodwill is considered to be "saleable", but Personal Goodwill is not. Here is a simple check list to determine Personal Goodwill or Enterprise Goodwill:

  • Is the value of the business or professional practice inseparable from the actions, skill, the expertise and reputation of the individual owner?
  • Is the value of the company, other than the hard assets, such that it cannot be Transferred without the individual?
  • Can the economic benefits of the company to be transferred be realized only through the performance of post-divorce services of the individual?
  • Is the revenue or the ability to acquire future income tied directly to the efforts of the individual?
  • Is the ability of the entity to attract referrals separate and apart from the persona of the individual?
  • In summary, make sure that your divorce attorney is aware of the key aspects of your business and the importance of you, individually, to the success of the business in an effort to avoid the perils of the Double Dip.

Hat tip for this article to Bruce Richman (CPA/ABV, CVA, CDFA™), author of the book Guide to Tax and Financial Issues in Divorce.

 

For more articles on assistance regarding business valuation, visit http://www.divorcemag.com/articles/Business_Valuation/.

Divorce in the New Year Protecting Your Business

January is the month of renewal – closing the door on the negativity of the prior year and planning for the challenges of the new year. Many commit to weight loss, exercise, or stopping smoking at the start of a new year as an opportunity to make improvements in their lives. On the other hand, some people use the beginning of a new year to make new personal beginnings, such as ending their marriage.

Planning for a divorce and new life may seem daunting. Not knowing what to expect can be scary and frustrating. In a Texas divorce, specific requirements must be met before someone will even be allowed to file for divorce. For example, a spouse must live in Texas for 6 months and in a particular county for 90 days to qualify to file for divorce in Texas and in that county.

When going through the divorce, marital assets and debts will need to be divided between the parties. Some people enter into a premarital agreement when they get married to ease the divorce process and define the division of assets and debts in the event of divorce. But, some spouses are unable to agree in advance as to the division of marital property upon divorce in Texas, which can lead to contested litigation. Also, some parents are unable to agree regarding each parent’s role with their children after divorce. Child custody issues can become expensive and time-consuming.

For those spouses who own a business as a marital asset, getting divorced and reaching a fair division of the marital estate can be even more complicated. A business entity is a separate marital asset – the individual assets and debts owned by the business are not part of the marital estate, only the entity as a collective whole. The first step in dividing a marital estate that contains a business entity involves establishing when the business was started. If it was formed prior to the marriage, it may not be community property under Texas marital property law. However, any changes to the organization, such as the entity type or owners may alter the initial characterization of the business as separate or community property.

After determining that the business is community property under Texas marital property law, the second step is to figure the business’s monetary value to the community estate. A CPA or business valuation expert will evaluate and establish the value of the business for property division purposes. It is recommended that the CPA be certified by the American Institute of CPAs in Business Valuations. The value will depend on many different factors, including the amount of assets the business has, properties that the business own, current customers, intangible goodwill, as well as other financial information.

Practically speaking, while the divorce works through the process, the business will need to continue to operate. Owner spouses need to know what to do to protect their investments while the divorce process is ongoing. This becomes even more important if both spouses work at the company and agreements need to be in place regarding each spouse’s rights, duties and responsibilities regarding running the business.

Once there is evidence of the assets and debts contained within the community estate as well as the value of each asset and debt, the parties by agreement, or the judge after a trial, will work to achieve a fair division of the assets and debts between the parties. The division does not have to involve a split of each asset and debt, but will contemplate an overall fair division. One spouse will receive certain assets, the other spouse will receive other assets, each spouse will be allocated certain joint debts, and each party will be assessed the debts in their name only.

If you are considering a divorce or have been served with divorce papers, contact an experienced divorce attorney, especially if you own a business. The decisions you make during this process could impact not only your personal financial freedom but also your business’s bottom line. You need to know what will be considered in the final split of the marital assets and debts.

Contact the Dallas firm of O’Neil Attorneys Family Law for your family law needs, including dividing your business assets upon divorce. Michelle May O’Neil and Ashley Bowline Russell are well-acquainted with the special concerns for complex property divisions in a divorce in Dallas Texas or the surrounding areas. O’Neil and Russell released their new book The Basics of Texas Divorce Law in December 2010. Find them online at www.themayfirm.com or www.oneilattorneys.com.

 

Why do we have to value my business to get divorced?

Frequently clients ask about their Dallas Texas divorce why we have to get a forensic CPA expert to value their closely-held business to get them divorced.

In Texas, there are three parts to dividing property in a divorce:

  1. Characterization -- is the asset community property (property obtained during the marriage) or separate property (property owned before the marriage or through gift or inheritance)
  2. Valuation -- assessing the value or net worth of each asset to assist in determining what is a fair division of property
  3. Division -- the physical aspects of sorting assets to each party

In order to dispense a "just and right division" of community property in a Texas divorce, the judge has to know how much each asset is worth.  In other words, until each asset has a dollar value, neither the judge nor the parties can know whether the division awards 50% of the assets to each party or some other figure. 

In a divorce with a business interest, the first step is to decide whether the business entity is community property.  This can be more complicated than just whether the business was started during the marriage.  Important questions include what was the source of funds used to start the business, did the business change formations during the marriage, and whether any community funds were put into the business during the marriage if the business was started before the marriage.  Also, consider whether the customers of the business come to the business due to the reputation of the business or the reputation of the spouse/owner.

Then the business must be valued according to appropriate principles to be used during a divorce.   In the market valuation approach, the CPA estimates your business’s value by comparing it to a similar business that has been sold recently. The income approach estimates the value of the business by converting profits or cash flows into value. The asset approach estimates the value based on the values of the assets and liabilities of the business. Note: the "book value" of a business, which is the assets minus the liabilities on the balance sheet, is not a valuation method used by professional business valuators.

Not just any CPA is qualified to conduct a business valuation in a Texas divorce.  The expert should be certified by the American Institute of CPAs in Business Valuations.  The letters after the CPA's name should read "ABV".  This accreditaion assures the divorcing spouse that the CPA has a minimum level of expertise in the relevant principles of valuation. If an expert is under-qualified to give an opinion on valuation of a business, the expert may not be allowed to testify at trial.

Divorce Business Valuation Approach

Calculating the value of a business can be one of the most important parts of a divorce because a closely-held business may be one of the most significant assets of the marital estate.  The best approach to such valuation is to hire an independent business appraiser—a CPA with an Accredited in Business Valuation (ABV) credential or a certified professional, like a Certified Business Appraiser (CBA) or someone recognized by the American Society of Appraisers (ASA).  Such expert will begin by obtaining all business books and records, tax returns, and financial statements and reports for at least the last five years.

Using this data, the appraiser will determine the company’s intangible and tangible net assets, an appropriate rate of return for them, and will calculate excess earnings in accordance with various accepted methods.

After finding a proper capitalization rate for the excess earnings (that which remains after taking into account normal costs, return on assets and salaries), the appraiser can place a value on the most contentious aspect of business valuation, the intangible asset known as “goodwill.”

"Commercial goodwill” is the capacity of a business to attract new customers, or keep old ones due to great locations, a reputation for superior service or skill, or anything else that influences a person, supplier or other business to continue a commercial or professional relationship. “Personal goodwill” describes the nontransferable ability of an individual to attract and maintain customers or clients due to his or her skill or reputation for honesty, intelligence, craftsmanship.

 

 

Business Valuation in Divorce -- List of Documents Needed

In any divorce where one of the spouses owns a business interest, that interest must be valued.  Usually in Dallas County Texas divorces, the attorneys will hire a forensic business valuation expert with ABV accreditation to perform such valuation services.  That expert will need certain documents in order to perform his valuation, including:

Financial Statements for Typical Corporation

  • Balance sheets, income statements of changes in financial position, and statements of stockholders’ equity for the last five fiscal years.
  • Income tax returns for the same years
  • Latest interim statements and interim statements for comparable period(s) of previous year

Other Financial Data

  • Summary property, plant, and equipment list and depreciation schedule
  • Aged accounts receivable summary
  • Aged accounts payable summary
  • List of marketable securities and prepaid expenses
  • Inventory summary, with any necessary information on inventory accounting policies
  • Synopsis of leases for facilities or equipment
  • Any other existing contracts (employment agreements, covenants not to compete, supplier agreements, customer agreements, royalty agreements, equipment lease or rental contracts, loan agreements, labor contracts, employee benefit plans, and so on)
  • List of stockholders, with number of shares owned by each
  • Schedule of insurance in force (key person life, property and casualty, liability)
  • Budgets or projections, for a minimum of five years (if management prepares)
  • List of subsidiaries and/or financial interests in other companies
  • Key personnel compensation schedule, including benefits and personal expenses

Company Documents

  • Articles of incorporation, bylaws, and any amendments to either
  • Any existing buy-sell agreements, options to purchase stock, shareholder agreements, restrictions on transfer, or rights of first refusal
  • Franchise or operating agreements, if any

Other Information

  • Brief history, including how long in business and details of any changes in ownership and/or any bona fide offers recently received
  • Brief description of the business, including position relative to competition and any factors that make the business unique
  • Marketing literature (catalogs, brochures, advertisements, and so on)
  • List of locations where company operates, with size and recent appraisals
  • List of competitors, with location, relative size, and any relevant factors
  • Organization chart
  • Résumés of key personnel, with age, position, compensation, length of service, education, and prior experience
  • Personnel profile: number of employees by functional groupings, such as production, sales, engineering/R&D, personnel and accounting, customer service/field support, and so forth
  • Trade associations to which the company belongs or would be eligible for membership
  • Relevant trade or government publication (specially market forecasts)
  • Any existing indicators of asset values, including latest property tax assessments and any appraisals that have been performed
  • List of customer relationships, supplier relationships, contracts, patents, copyrights, trademarks, and other intangible assets
  • Any contingent or off-balance sheet liabilities (pending lawsuits, compliance requirements, warranty or other product liabilities, estimate of medical benefits for retirees, and so on)
  • Any filings or correspondence with regulatory agencies

Download pdf here: Preliminary Documents and Information Checklist for Business Valuation of Typical Corporation or Business Entity

View online here:  Preliminary Documents and Information Checklist for Business Valuation of Typical Corporation or Business Entity

Minimizing Your Business Value in Divorce

When spouses own a business and they are getting divorced, the value of the business becomes a major focus of the division of property.  Dallas Texas Board Certified Divorce Lawyer Michelle May O'Neil explains the concepts of valuation of a closely-held business entity that affect and even minimize the value of a closely-held business entity:

Valuing a business is a complex, and often expensive part of a divorce.  A business consists not only of tangible assets like buildings, bank accounts, inventory, tools, fixtures, furniture and machinery; but also, intangible ones such as mortgages, leases, patents, trademarks, unlisted stock, skilled labor, accounts receivable and most notably, “goodwill.” A business is valued usually based on the fictional assumption of a sale between a willing buyer and willing seller.

The most common legal concept that affects the value of a closely-held business is the distinction between the personal goodwill and commercial goodwill of the business.  The personal goodwill is that goodwill attributable to the person of the business owner.  Take a small bookkeeping firm, for example, owned by a wife.  Most of her clients do business with her company because they like her and trust her work.  her business has no reputation separate from her.  That value of the business attributable to her presence is personal goodwill.  The value of a business attributable to personal goodwill is the spouse's separate property.

Commercial goodwill, on the other hand, is that  goodwill that exists independent of the business owner.  It is the independent reputation of the ABC Company that exists separate from the business owner.  The value of a business attributable to the commercial goodwill is community property if the business would otherwise be community property.

Also diminishing the value of a business is the frequent occurance where a business remains subject to the control of multiple owners.  This discounts the value to any one of the owners for lack of control.

Another factor that decreases the value of a business involves marketability, which is defined as the ability to convert an investment into cash quickly at a known price and with minimal transaction costs. The more difficult a business would be to sell, the greater the discount for marketability.

Many businesses have "Buy/Sell Agreements".  These cannot be relied upon to calculate a business' value.  Such agreements typically protect the majority partner interests and rarely reflect actual value.

The best way to approach valuation of a business entity in a divorce is to hire an independent business appraiser—a CPA with an Accredited in Business Valuation (ABV) credential or a certified professional, like a Certified Business Appraiser (CBA) or someone recognized by the American Society of Appraisers (ASA).

Keeping Business Alive During Divorce

Divorce is a hard enough time but when you own your own business, managing your divorce and keeping your business alive can be extra challenging.  Here are some tips from Board Certified Dallas Family Lawyer Michelle May O'Neil of O'Neil Anderson:

  • Be an open book.  Don't try to hide anything from your spouse.  When discovered, the divorce judge may very well impose greater punishment than the value hidden.
  • Hire a good forenic accountant to evaluate the business.  If the business is community property, the value of the business to the community estate will be an essential question in the divorce.
  • Know the difference in personal goodwill and commercial goodwill and how that difference may affect the consideration of your busines sin the division of your community estate and divorce.
  • The declining economy may have removed much of the liquidity from your business, which may affect the cash available to pay the increased expenses of separating and paying divorce lawyers.
  • If both spouses work in the business, it is best to pick one who will stay in the business and one who will exist.  Rarely can people who cannot stay married to each other remain business partners.