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Joseph E. Cordell

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Family Businesses Can Be Under Siege In Divorce

Posted: 10/14/11 12:20 AM ET

If you're a small business owner, a divorce can be reminiscent of "Little Shop of Horrors." But instead of carnivorous plants chanting, "Feed me!" it's your soon-to-be-ex who is the hungry one. For your cash, that is.

Not only is the family business usually the largest marital asset, it's also often the family's main income source.

In order to make a distribution of property in a divorce, it is necessary to determine the value of the marital assets and debts. This difficult, complex task is exacerbated when a family business is involved because spouses tend to develop two different syndromes during the valuation phase, according to the divorce lawyers for men at Cordell and Cordell.

One spouse is afflicted with Sudden Business Losses Syndrome. Symptoms include arguing that the business is tanking and worth nothing. The other spouse invariably contracts Sudden Ivana Trump Syndrome whose side effects include thinking the business is the next Apple Inc.

The spouses will then dig in their heels, fight over whose value is right, and watch as no one wins except for their divorce lawyers' coffers. A judge may ultimately have to decide the value of the business.

In order to avoid this costly scenario and deal with your small business effectively, you need to decide what your business is and choose your valuation method.

First, when deciding on the business division method you need to determine if your business is "property" or "income." This is not just a semantics lesson.

If your business is labeled as "property" (e.g. making money with tangible assets such as an apartment complex), then it is subject to your state's divorce laws for property division.

However, if you call your business "income" (e.g. making money with intangible assets such as a divorce lawyer's practice), then it could be subject to alimony award rules.

The difference? Many states award each spouse one-half of the marital "property" but rarely would a spouse be awarded one-half of the other's "income" as alimony.

When a business is deemed both "property" and "income" then you need to be careful to separate the two in order to avoid a double dip.

If you did not segregate the property from the income, then your business as property could be divided with your spouse receiving her share in addition to you being forced to pay alimony based off the income from the already-divided business.

That's double dipping.

Next, choose your valuation method wisely. It is fairly easy to determine the value of public companies, but family-owned businesses pose a much greater challenge because there is no established market for the sale of those companies.

Choose the wrong method and you could over-value your business and pay more to your ex than it's worth, thus the importance of choosing a method that focuses on certain factors favorable to you at your spouse's expense.

For those with Sudden Business Losses Syndrome, the fair market value method is a popular choice.

This method treats the business as if it were an item of property sellable on the open market. This works well for the unique business (e.g. a decorative spoon collectible store) and the dime-a-dozen one (e.g. a greasy, corner diner) because where the demand is low so is the value. A low purchase price for a hypothetical sale is ideal for the Sudden Business Losses Syndrome-type.

Those with Sudden Ivana Trump Syndrome enjoy using the capitalization of earnings method, which treats the business as a revenue stream valuable to its owners if not to the hypothetical buyers in the open market.

The capitalization rate is based on the rate of return for similar investments, the risk, and the business's historical earnings. So the Sudden Ivana Trump Syndrome spouses will make the cap rate as high as possible in order to justify these phrases:

• "That custard stand is the next Dairy Queen." (rate of return for similar investments)
• "Nothing is as reliable as this business." (minimizing risk)
• "Business was down that year, but look at the trips we took and clothes we bought." (glossing over low-earning years)

After all, the more the business generates for its owners, the more valuable it is - and the more to divide in divorce.

Finally, it is wise for one spouse to buy out the other's interest in the business. If each spouse retained a share and remained involved in the business, disagreements can and will happen.

For the spouses who each take a one-half share, expect a deadlock on any decisions. For the spouse who retains a minority interest in the business, expect oppression.

Remember, you got divorced for a reason.

The process of determining the value of a small business can be very complicated. Your divorce lawyer should be able to assist you in selecting a business valuator and in interpreting the valuator's report.

Joseph Cordell is the Principal Partner of Cordell & Cordell, a nationwide domestic litigation firm focused on men's family law matters. Cordell & Cordell also provides a website dedicated to informing men on the divorce process and the challenges they face. Visit http://www.dadsdivorce.com for more information