What Happens to a Family Business During Divorce? A Guide to Business Valuation

A divorce is for sure a complicated affair. One shared life of two parties splits into two separate lives, and so do all the assets. 

Under California law, assets acquired during the marriage become community property. This means that it is generally split 50/50 in a divorce. However, some assets are not always easy to split. 

Things get messy when property division involves a family business. Generally speaking, courts will treat it like any other property. However, the stakes are higher because family businesses are tied to income, identity, and other family members.

The first thing to do is determine what type of property it is. Is it considered marital property (subject to division) or separate property (owned by one spouse)?

• Marital property: If the business was started during the marriage or grew significantly during the marriage, it is usually subject to division.

• Separate property: If one spouse owned the business before marriage and kept it financially separate, it may remain theirs. However, any increase in value during the marriage could still be shared.

How to Protect a Business

If you have a business, now is the time to protect it, before a divorce happens.

• Use prenuptial or postnuptial agreements. A prenup or postnup is the strongest line of defense. They clearly define the business as separate property and can specify how future growth or appreciation will be treated. Without one, even part of a pre-marriage business can become divisible if it increases in value during the marriage.

• Keep business and personal finances completely separate. One of the biggest mistakes owners make is commingling funds, but this is easy to do. You must maintain separate bank accounts and credit cards and avoid using business accounts for personal expenses. If finances are mixed, courts may treat all of the business as marital property.

• Document ownership and contributions. Keep records of when the business was formed, ownership percentages, capital contributions, and each spouse’s role. If your spouse contributed in any way, the court may award them a larger share, even if they are not technically an owner.

• Limit spousal involvement in the business. The more involved a spouse is, the stronger their claim may be. Working in the business, managing books or operations, or helping grow the company without compensation can all strengthen a claim.

How Business Valuation Works

In California, courts typically use fair market value, which is what a willing buyer would pay a willing seller under normal conditions. This applies to most businesses and professional practices. It is usually determined as close to the trial date as possible, but can be adjusted if fairness requires a different valuation date.

There are three main business valuation methods:

• Income approach. This is the most common method. This method focuses on earning power and future income. It projects future profits and discounts them to present value. It also uses past earnings to estimate future value. The income approach is best for service businesses and professional practices (such as doctors and lawyers). 

• Market approach. This method compares your business to similar businesses that have sold, relying heavily on available market data. This is best for retail, franchises, or common industries.

• Asset approach. Under this method, business value is determined by assets minus liabilities. This method is best for asset-heavy businesses (such as construction, manufacturing, and real estate holding companies). 

There are also two main formulas used to determine a business’s increase in value during the marriage. The Pereira and Van Camp formulas are legal methods used by courts in California to decide how to divide a business that one spouse owned before marriage but that increased in value during the marriage.

The Pereira formula is generally applied when the growth of the business is primarily due to the active efforts of either spouse, such as management, decision-making, or labor during the marriage. Under this approach, the court assigns a reasonable rate of return to the original separate property. That portion remains separate property, while any additional growth is treated as community property because it resulted from marital efforts.

The Van Camp formula is used when the increase in value is mainly due to external or passive factors, such as market conditions or brand strength, or the inherent nature of the business. In these cases, the court calculates a fair salary for the working spouse during the marriage, subtracts any compensation already received, and treats the remaining amount as community property. The rest of the business value is then considered separate property.

Business Division Options

California courts use practical options to preserve the company’s value while compensating both spouses. Some options include:

• Buyout. This is the most common option. One spouse keeps the business and buys out the other’s share. The business is professionally valued. The owning spouse pays the other spouse their share (often 50% of the community portion). Payment can be a lump sum, installments over time, or offset with other assets.

• Asset offset. Instead of cash, one spouse keeps the business while the other receives equivalent assets. The business owner keeps the company, while the other spouse may get the family home, retirement accounts, or investment portfolios.

• Co-ownership after divorce. This is when both spouses continue to own the business together post-divorce. This is rare but may happen in amicable divorces or in family-run businesses where both spouses play key roles.

• Sell the business and split the proceeds. The business is sold, and the proceeds are divided between spouses. This is more likely to occur when both spouses want a clean break or the business is not viable without both parties.

Contact Us Today

In California divorces, marital assets are split 50/50, but things can get more complicated when a business is involved. 

Get the legal help you need from Arcadia divorce attorney Ashley A. Andrews, APC. We can help you understand property division after a California divorce. We will guide you through splitting up assets and property, taking into consideration the valuation of business entities. Schedule a consultation today by calling (626) 346-0114 or filling out the online form.

This material is provided for educational purposes only. Providing this information does not establish an attorney/client relationship. None of the information contained in this post should be acted upon without first consulting with an experienced family law mediator and attorney. Should you have questions about the content of this post, please arrange to discuss via a consultation.