One of the significant issues in some divorces is valuing a business operated by one spouse. A business can be a valuable asset, and valuation issues can be complicated and produce a fair amount of dispute.
Before getting into non-competition clauses as part of the sale of a business, and how they relate to valuing a business in a divorce, first a more general discuss of business valuations, and particular issues in business valuation relevant for a divorce.
Issues that come up in any business valuation, including those outside of a divorce, can arise in valuing a business as part of a dissolution of marriage. There are the technical, financial factors that go into valuing a business – value of assets, multiples of income, industry data and trends, and other financial and business variables and analyses. In a divorce, one spouse might seek to arrive at a low value for the business, while for the other a higher value is better. There is the issue of whether non-business expenses are going through the business, decreasing the business’ net income and the arrived at value of the business also. One spouse may have a sense the other spouse is outright hiding income, and sometimes that is true.
Special Valuation Issues in a Divorce – Personal and Enterprise Goodwill
One issue that sets business valuations for a divorce apart from other valuations, is that the value of a spouse’s work, and the income generated from people who seek out the business because of the spouse’s skills, abilities, reputation, etc., although part of the value of the business, are a “non-marital” component of the value. This personal, non-marital portion is backed out of the value of the business in calculating the marital portion of the value of the business, and asset value divided in the divorce.
This component of the value of the business, i.e. the portion of the value attributable to people spending money on the business because of the spouse, is called “personal goodwill”. The value of the business as a marital asset for the divorce is calculated based on what the value would be if the spouse was no longer there, and the business lost this personal goodwill.
So if a business generates annual net-income of $300,000, has actual assets (e.g. equipment) with a fair market value of $20,000, and is valued at $620,000 with the spouse there, but no one would come to and the business would have no revenue if he or she left, then all of the value of the business other than the assets is personal goodwill; and the value of the marital portion of the business is $20,000, i.e. the value of the assets.
One example of this type of business is a professional practice like an accountant or other professional, where people seek out the business because of that professional. A business can have another type of goodwill also – enterprise goodwill, i.e. people coming to the business because they know the business. An example is a company like Amazon or department store like Saks Fifth Avenue. Some people probably go to Saks Fifth Avenue versus another store because of a particular salesperson who works at Saks, but seems a valuation expert would view the value of employees like this (versus an owner selling and leaving the business) as part of the enterprise value of the business. It is possible, however, for the value of a business to include both personal and enterprise goodwill.
These days, it seems that even businesses whose values traditionally have been considered as all or mostly all personal goodwill, can have a larger non-personal goodwill component. Many businesses have websites, and some websites have strong SEO value, i.e. do well in search engine searches like Google searches and people find the business that way. This would be an issue for a expert to evaluate if valuation is a significant issue, but seems a website that generates leads and income has value, probably most accurately as an asset rather than as a form of enterprise goodwill (when potential customers do Google searches very often it’s not that they know the company and search for the company, but rather search for whatever product or service they want).
There can be situations where it is mixed, i.e. where there is both personal and enterprise goodwill. From talking with valuation experts, and taking a bit of a common sense approach, one way to look at a situation where there is both personal and enterprise goodwill is to consider how much of the income of the business would leave if the spouse is no longer there – with the portion that remains reflecting enterprise goodwill, and the portion that would leave with the spouse as personal goodwill. If we take our last example of $300,000 annual income, $20,000 assets, and $620,000 value; and if $150,000 of income/year would leave if the spouse left and the value of the business would decrease to $320,000; then the personal goodwill component of the value of the business would be $300,000, and the value of the marital portion of the business the $320,000. A business valuation expert would probably put some finer points on this example/analysis, but this is the general idea and result.
Although spouses can decide to sell a business as part of a divorce and divide the proceeds, more frequently one spouse keeps the business and stays – so the spouse is not actually leaving with the resulting loss in income. However, we calculate the value of the business as if the spouse was no longer there, because for the divorce we need to determine the value of the marital portion of the business, which does not include the value of personal goodwill.
Continued in Part II, Non-Competition Clauses and Collaborative Divorce