When dividing assets at divorce, one of the more challenging jobs is how to divide the value of a business that one or both of the parties owns. Usually, the business is the source of the family’s income, and after divorce, it will become the source of alimony and/or child support. Usually, also, the business owner-spouse does not plan to sell the business, at least not for a long while, because it is the best way for this person to generate income and, therefore, support. Often, this business owner doesn’t think that he or she will ever sell it, and may not even realize that the business is a “marital asset.”
Yet, the law defines the business as a piece of property to be factored into property division, so it has to be considered. How, then, do we figure out the value to be assigned? This generally done by use of what are called “experts”, most often accountants with special training in business valuation. In simplest terms, the expert (s) (either one hired by each spouse separately, or often in mediation for example, one jointly hired person) decide (in very simplified terms) to value the company by estimating the kind of income that the company may generate for the business owner in the future and how much another person or entity would pay for that expected income.
Then, historically, valuation experts would reduce the estimate just described by factors known as “discounts”. These were used to account for such factors as the lack of a large number of others prepared or desiring to buy a small company (called “marketability”), or in situations where the business owner does not own a large enough share of the company to control the company him or herself (called “lack of control”) or the belief that the business owner is personally critical to the success of the business (called “key man”). These discounts often reduced the value of the business owner’s property interest by 15 – 30 per cent.
This all began to change in 2007, when the Massachusetts Supreme Judicial Court (SJC) decided a case that involved a man who owned two grocery stores on Martha’s Vineyard, called Bernier v. Bernier. On appeal from a trial decision, the SJC learned that the business owner-husband had no intention of selling the business. Because of this, the court concluded that it was not fair to the wife to reduce the value by factors related to a sale, when a sale was not expected to occur. The SJC believed the real value that was relevant to the case was the value of the expected income to the husband himself in the future (since he was keeping the stores), and the value to a hypothetical buyer.
Many experts called this change in focus a shift from “fair market value” (what a buyer would pay) – the traditional value in divorce cases -- to “fair value” (what the future income is worth to the spouse keeping the business). Because fair value implies that no discounts should apply, the result is usually a higher value and results in the non-owner spouse receiving more of other property to offset this higher business value.
A very recent case, Caveney v. Caveney, supported this view. A trial judge applied discounts to reduce the value of the business owner-wife’s 24.75 per cent interest in a business run by her father. The husband appealed these discounts and convinced the Massachusetts Appeals Court (an intermediate court that hears many more divorce appeals than the SJC) that because “the sale of the business is not imminent” that the discounts were wrong. The Appeals Court reversed the trial judge’s decision. The Caveney Appeals Court actually referred to the use of the “fair value” approach, confirming in the minds of many that this is actually the value premise to be used in all cases in the future where a sale is not contemplated.
This blog entry is a very simplified discussion of these issues, which tend to be very complex and full of individual judgment. In mediation we discuss these concepts and others that are difficult and important. We also encourage clients to have independent counsel to help them understand and know how apply and respond to these issues. People’s sense of “fairness” is certainly affected by the side of the question the person finds him or herself. What do you think?