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August 7, 2020
Three Commonly Used Approaches for Business Valuation in California

Valuing a business in the divorce context will not be the same as valuing a business in other legal proceedings. The value in a bankruptcy, for example, is going to be very different compared to the value that you will see in a divorce. Although there are several ways a business can be valued, one method is used far more often in the family law setting compared to other methods.

1. Market Approach
The market valuation approach considers what the business would sell for if the company was sold immediately. This method has been inappropriate in the family law setting unless you have some unique facts. For example, if both parties want to get out of the business and plan to sell it either during the divorce or shortly, a market valuation approach might make sense. It might be a suitable method if the parties are nearing retirement as well.

However, in most cases, the market valuation approach is not used because it does not account for future income very well. Even if one or both parties want to sell the business, there will be some concern that the sale price is inaccurate. Selling the business quickly as a “fire sale” likely will not get the company’s total value.

2. Asset Approach
This approach considers the value of each asset for the business. You add the value for each investment together to get an overall value for the company. This approach is not used frequently because it does not capture future earnings well. However, it can be a good idea for “asset-heavy” businesses, such as construction companies or real estate holdings.

Many business valuations in the divorce context will use a hybrid approach that combines the income approach and the asset approach. That way, both the future value of the company and its current assets are considered part of the valuation.

3. Income Approach 
The income approach looks at the estimated income for several years. It then calculates the present value of the payment so that it is viewed in “today’s dollars.” The income approach is more commonly used, but it has some drawbacks as well. For example, it may not accurately account for the value of assets in the business.

An expert will review the income information and develop a capitalization rate, a real estate valuation measure used to compare different real estate investments, for the income estimate. The capitalization rate will have a significant impact on the overall value of the business. This rate is based on the risks associated with future earnings for the company. The rate for most small businesses is between 20% and 25%, but the rate varies based on the history of the company, industry, and many other factors.

This method is the one most often used in family law proceedings.

If you are considering divorce that will involve a business, the valuation of that business will be a crucial aspect of your legal proceeding. Learn more about how we can help by contacting our team to schedule a consultation.

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