Starting and growing a small business requires significant effort. When a couple undertakes this journey together, both partners are invested in the success of the business. If the owners decide to divorce, one of the key decisions they face is determining the future of the business.

Business owners in this situation have several options to consider. A key factor is whether there is an existing marital agreement that specifically addresses the small business. If such an agreement exists, it will dictate how the business is treated. In the absence of a prenuptial or postnuptial agreement, the couple may explore the following options:

Shut down the business

One option is to close the small business, which is often chosen when the company is not profitable. In this situation, all outstanding debts need to be paid and settled promptly. This situation could greatly impact the division of property, particularly if the debts are substantial.

Business debts will first be deducted from the sale proceeds of the business, and any remaining amount will then be divided between the couple. If the debts exceed the sale value of the business, each partner may be responsible for a portion of the remaining debt.

Sell the Business

Another option to consider is selling the company. In this scenario, the business is evaluated, and the profits are likely to be divided as part of the property division process. One potential downside to this approach is that it may take time to find a qualified buyer for the company.

Continue to Run the Business together

In some cases, both owners may want to continue owning and operating the business together. It is essential to outline their rights and responsibilities clearly in a partnership agreement. To maintain the business as a partnership, the owners must be able to set aside personal issues related to the divorce and work together cooperatively.

A small business can be one of the largest assets a couple needs to manage during a divorce. This process can be quite challenging, so it may be beneficial for both parties to have legal representation.

Buy your partner out of the business

In some cases, one spouse may wish to continue running the business. That spouse can initiate a buyout of the company by negotiating an agreement where the spouse who is not keeping the business receives a larger share of other marital assets. Alternatively, a cash buyout can be arranged. This option requires a business valuation.

Your business valuation can be assessed based on several factors, including total assets, total liabilities, current earnings, and projected earnings. These projections should take into account the quality of your idea and its market potential. While there is no single correct method for determining this valuation, it’s beneficial to approach it from various perspectives. This allows potential investors or partners to see that you have conducted thorough due diligence.

1. Book value of your business (asset value) - To calculate your business's net worth, take the total value of its assets and subtract its total liabilities. This method provides a straightforward approach to valuation since it is based directly on the business's accounting and record-keeping. However, it's important to note that this calculation represents a snapshot of the business's current value and may not account for future revenue or earnings.
2. Cash value analysis - Understanding cash flow analysis is crucial for your business, as it allows you to assess both current and future potential earnings over a specific period. If you haven't developed this perspective yet, seeking assistance from a CPA, using online accounting software, or consulting a financial planner can be beneficial. Another useful method is a discounted cash flow analysis, which takes into account the present value of money in light of future economic conditions.
3. Revenue multiplier - A simpler yet still popular method to quickly evaluate a company's potential value is to multiply its current sales or revenue by a "multiple" factor. For instance, if a company has $200,000 in annual sales and a multiple of 5, its estimated worth would be $1 million. The higher the investor's confidence in receiving a return on their investment, the easier it is to justify a higher multiple. The multiple applied can vary significantly based on a range of factors, including:
   1. The industry: Competitive landscape, profit margins, macros trends, risks, etc.
   2. Market potential: Is there a market for your idea? Learn how to test the market for your business idea. If there's potential, how much money does an investor think your business could make in the short or long term?
   3. Timing: When will your business start making money, or how fast will it grow? Investors generally like a quick return, but some may be patient enough to stick around long term, with the hope of realizing the full potential of a business' success.
   4. Management team: The value you and/or your team brings to the company and your ability to improve its potential for growth.
   5. The idea & the investor: The better the idea, usually determined by how much value or growth potential it offers, the more an investor might pay. Different people may value your idea differently, based on their opinions, expertise and more, so don't take one valuation as the final answer.

While the revenue multiplier is considered one of the easiest methodologies to determine the value of your business, for credibility, it's best to have this done by an independent third party. Because valuations can vary wildly between firms, it is sometimes recommended that parties obtain multiple valuations to be negotiated.

1. Earnings multiplier - This method, also known as a price-to-earnings ratio, is more widely used if you have shareholders. This method takes the Price Per Share (PPS), the current market trading price of a company's share, and divides it by the Earnings Per Share (EPS). This gives you the net profits earned by the company per share in the market. The higher the EPS, the better. Ultimately, this allows comparison between the share price of a company to similar companies in the market. You may have to prepare two views: one that shows earnings before taxes and one after taxes.

While we will not pretend to be business valuation experts, our experienced attorneys can pair you with those experts to ensure that your business is correctly valued for the purposes of your divorce.

Why is Legal Guidance necessary as it pertains to small businesses in divorce cases?

Small businesses are often incredibly significant to the family unit. It can be not only a great source of income, but one of pride and love as well. Many people invest themselves heavily into their sole or family businesses and the worry of losing something they’ve poured so much of themselves into is deeply personal. Whether couples choose to close down, sell, buy each other out, or operate the business together, our experienced attorneys assist in exploring all available options and ensure that, regardless of the route you choose to go, your legal rights are protected.