When Assets are Divided: Goodwill in Divorce
One of the most wearisome aspects of divorce is when there is a division of assets. While some marital assets are readily divisible, such as a joint bank account, other assets, such as ownership in a privately held business, are not. In the case when a spouse is active in the business and wants to continue in the day-to-day operation after the divorce, the sale of business ownership and division of the proceeds might not be an option.
Tangible and intangible assets
A business’s value is made up of two components: tangible and intangible assets. Tangible assets, or hard assets, include cash, receivables and equipment and are recorded on the business’s balance sheet. Generally, intangible value equals the difference between the business’s fair market value and its net tangible value. Divorce courts frequently lump all intangible value into a catchall phrase called “goodwill.”
Business appraisers in divorce cases know that goodwill is an essential concept they must master. Goodwill is typically categorized as one of the following:
- Enterprise goodwill is connected to the business itself. Businesses with an assembled workforce, accessible locations, and a brand name most likely have enterprise goodwill.
- Personal goodwill is connected directly to the actions of the owner and is not easily transferred to a buyer such as an owner’s reputation, skills and personal efforts.
Since divorce is a state matter, each state observes different rules as to how to treat goodwill, and the treatment of goodwill depends on state law, case facts and relevant legal precedent. Even with varying state laws, the treatment of goodwill falls within one of the following classes:
- Neither enterprise nor personal goodwill is marital. The appraiser separates business value into tangible and intangible components and only tangible assets are included in the marital estate.
- Enterprise and personal goodwill both are marital property. The appraiser makes no distinction between personal and enterprise goodwill.
- Enterprise goodwill is marital property. Personal goodwill is specifically excluded from the marital estate.
Ohio law treats marriages as an economic partnership, with the starting point for the division of the marital asset as 50%-50%. Furthermore, personal goodwill in Ohio is a marital asset and is subject to division the same as other marital assets owned by the spouses. But if the business is sold during the divorce, a division between enterprise goodwill, personal goodwill and other specific assets might be needed to determine the tax implications of the sold business.
Offset from other marital assets
After the value of the business is determined, the next question is how to offset the value without requiring the sale of the business or impairing the business’s operations by removing cash or other equity. Cash, savings or liquid investment may be insufficient to offset the value of the business, so other tactics need to be considered in the division of the marital assets. This could include ownership of the family home, payment plan, non-voting stock in the business or other methods to secure the other spouse’s interest in the business.
The division of business ownership becomes more complex when the business is a service business or professional practice and the spouse is the principal revenue generator and the future-generated earnings depend on the character of that spouse. A fundamental element of business valuation is the value of a business is equal to the present value of the future benefit. In this scenario, the future benefit is dependent upon the business-owning spouse.
Double-dipping is the double-counting of a marital asset in the property division and again in the support award. It is based upon the fact that the same cashflow or earnings that was considered in the valuation are also considered in the spousal support.
If the court orders the business-owning spouse to pay spousal support and divides the business value in half (if based upon future anticipated earnings), it effectively amounts to double-dipping. The income used for spousal support needs to be reconciled with the earnings used in the business valuation to ensure the same earning are not used twice and prevent the double-dip.
We can help to establish the value of ownership interest and present an income analysis. This analysis can be reconciled to business valuation to prevent inequities when addressing the separate but interrelated issues of spousal support and division of business interest.
Bryant D. Petersen?>
MBA, ASA, CFE
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