Episode 132 - How to Divide A Business in a Divorce
Leh
Meriwether: Welcome, everyone.
I'm Leh Meriwether. With me is Todd Orston. Todd and I are partners at the law
firm of Meriwether and Tharp, and you're listening to the Meriwether and Tharp
Show. Here, you'll learn about divorce, family law, tips on how to save your
marriage if it's in the middle of a crisis, and from time to time, even tips on
how to take your marriage to the next level. If you want to read more about us,
you can always check us out online, atlantadivorceteam.com.
Leh
Meriwether: Well, last week,
you know, what I love about this show is we can shift massive directions like
which way we're going. Last week, we talked with Matt Driggers about a type of
counseling that I'd never heard of before. You haven't heard of it before
either. Discernment therapy, which is a great alternative to marriage
counseling because sometimes marriage counseling is just a waste of time and
money, whereas discernment therapy could potentially save a marriage or make
the divorce a lot less painful, so if you're curious about what that is, you
definitely want to listen to the last show. You can find that at
divorceteamradio.com.
Leh
Meriwether: But today, big
time shifting gears.
Todd
Orston: Absolutely.
Leh
Meriwether: We are shifting
from discernment therapy to how do you deal with a business in a divorce? What
happened, recently I actually did a seminar, it was a national seminar. Well,
we call it CLEs, for Continuing Legal Education, and that's where we as lawyers
have to, to maintain our bar license we have to attend seminars. They're called
Continuing Legal Education seminars, and this one I was actually presenting at.
It was a national one dealing with how do you handle a business in a divorce.
Sometimes the question, depending on the type of business, it can be very, very
serious.
Leh
Meriwether: I mean, I think
the biggest one we've ever seen was Amazon, Jeff Bezos. We had a whole show
about that and how he was a majority shareholder in it. That was the majority
of their assets, and how with Mackenzie, that was her name, right, that's his
wife's name, Mackenzie, how would they split all that up. How would you deal
with it? As I understand it, she actually had a I think she got, what, $38
billion, so she didn't even get half, but how do you survive?
Todd Orston: I mean, I just don't
understand.
Leh
Meriwether: She got a very
small, as I understand it, a small portion of the stock so it didn't create an
issue. I think he's still the majority shareholder. Sounds like they worked out
something that they felt was fair.
Todd
Orston: And we
understand. Not everyone listening owns an Amazon-like business, but a lot of
the concepts are going to be the same, and there there were a lot of things
that had to be considered, because in a perfect world we could take all the
assets and just divide it right down the middle. We could say 50/50 and we'll
figure out what that looks like, but everybody walks away with the exact same
thing or the exact same amount. But when you're dealing with a business, like
when he was dealing with Amazon, that's no possible. By doing that there are
absolutely immediate consequences on ownership interest in that business, which
then deals with issues of control, and so splitting 50/50 of that asset just
wasn't possible.
Leh
Meriwether: Right.
Todd
Orston: Then you look at
what they actually-
Leh
Meriwether: Well, it was
possible, but there could have been really negative consequences.
Todd
Orston: Exactly,
exactly. So basically they were able to work something out. She was I guess
treated fairly with 38 billion.
Leh
Meriwether: That's my
understanding.
Todd
Orston: My mouth almost
doesn't even make, I can't even say those words. That's alien to me. But they
were able to work it out and was it a 50/50? No. Was she still treated very
fairly and were things done in a way to maintain his control over the business
and maybe that might have translated to some alimony issues or some additional
monies that were paid? I don't know. But the bottom line is that it wasn't
50/50 but it was fair. These types of considerations even when you're not
dealing with Amazon, you have to consider these things and that's what we do.
Leh
Meriwether: So we're going to
talk about, because I think Amazon, that is a unique animal.
Todd
Orston: Absolutely.
Leh
Meriwether: We're not going to
be talking about that. We're going to be talking about what we see most common.
We see businesses that are making anywhere from $100,000 to millions of
dollars, 10, 20, 30, 40 million dollars and up. I think the most common ones
you see are making anywhere from $100,000 to $10 million. That's the bulk of
them, and there's actually certain plateaus. Certain businesses hit a million
and sort of plateau out. Sort of the next as I understand it, $10 million is
the next place where businesses can stall and then they grow. But that's where
you see the bulk of them, in that range.
Leh
Meriwether: So today we're
going to talk about, I'm not going to be talking as a lawyer explaining things
to other lawyers. I'm going to be talking to the business owner or the person
that's married to the business owner. We're going to talk about how to break
these, how do we deal with them in a divorce? We've had cases where both
couples were very involved in the business, and what would happen if one of
them left? Would it cause the business not necessarily to collapse but how
integrated were they in the business? I've seen cases where both of them were
integrated in the business but the employees only liked one of the owners.
Todd
Orston: I've seen that
quite often, actually.
Leh
Meriwether: But the other one
was sort of in charge, the one the employees didn't like, and it wasn't because
he was in charge that they didn't like him or her, it was the way they treated
the employee.
Todd
Orston: Well, I've also
seen where they're both involved but let's say it was a service-related
company, and the one that the people didn't like as much was really the hands
on, day to day providing of services to customers and the other one was the
back office, basically kept the office running, kept the business going. So
who's more valuable? The one who's going out performing the work with customers
or without the person behind the scenes, they would have closed up shop years
earlier because they-
Leh
Meriwether: They paid the
payroll.
Todd
Orston: They took care
of payroll, they took care of all the bill pay, dealing with vendors and subs
and whatever is needed in the business. Again, these are all considerations, so
sometimes it's not easy to just surgically remove one party from the business
and assume that the business is just going to be able to keep going and be
successful.
Leh
Meriwether: And just, we're
going to touch on using business valuators. I'm not going to go, even though
that's what the topic was, how do you value a business, part of the
presentation was dealing with stock options, which is another complicated. Some
areas that can complicate a divorce, especially if you have a CEO or somebody
who's received a substantial amount of stock or stock options. How do you value
it, how do you deal with a divorce? We're not getting into that today.
Leh
Meriwether: We are going to
bring on one of our business valuators that we really like, because he does
such a great job. His name is Seth Murphy, and the reason we like him is
because he's not a hired gun. Some people will say, "How much do you think
the business should be worth?" And they'll see if they can get it there.
Seth is like, "Here's my honest opinion what it's worth, here's what I'm
willing to testify in court what it's worth." He's really upfront with
you, so we like him for that reason. His math and approach is sound.
Leh
Meriwether: But we're going to
touch on what evaluators do and then we'll save the deeper dive for when he
comes on the show. The first thing I wanted to touch on is the different types
of valuations that can be done. Sometimes as a certified business valuator, one
of the things that he can do is do what's called a calculation of value.
There's two types of opinions that that can present, a calculation of value and
a business valuation. The calculation of value, it's a much simpler one. It's
the least expensive one, but at the same time it's not one that he likes to
testify in court about. The business valuation one is... I don't want to say...
They're both legitimate, but the business valuation is much more detailed, it's
supported by more data.
Todd
Orston: Yeah, it's a
quick and dirty valuation process to try and get parties to a point where maybe
they can reach an agreement as to numbers, and usually that's going to be a
better option or just an option. Where the parties are working amicable towards
a resolution, meaning you're not getting, there's not huge hangups on the
property valuation and things like that, but they need a working number that
they can both agree on because the alternative is, like you said, much more
complex, much more in depth, and much more expensive.
Leh
Meriwether: More expensive.
Yeah. That's a great point. With the calculation of value, you can have two
very reasonable people. They've made the decision, we're getting a divorce, and
they say, because they're reasonable, they don't want to argue about the
business valuation. They're like, "You know what, can we have a third
party just give us a rough number, and if it sounds good, we'll just both
accept it and then work from there." Going back to the whole thing, if
they're saying, "We're trying to be fair to each other," the
calculation of value is a great option there because it's a rough, I think one
time he said the back of the napkin approach. He gives a rough number.
Todd
Orston: Based on
analysis.
Leh
Meriwether: Based on analysis.
It's just not a super deep analysis.
Todd
Orston: It's not a deep
dive.
Leh
Meriwether: Yeah. And often
that's all that's needed, and it's very helpful to them. We're going to talk
about that. We're going to talk about what's involved with the business
valuation. We're going to talk about the different valuation approaches,
because there's three different approaches that business valuators use in coming
up with an overall value of the business. We're going to talk about that and
then we're going to spend a large portion of the show talking about, okay, now
that we have a value, how do we divide this up? What options are available to
the business owners in the divorce so their business doesn't go under after the
divorce?
Leh
Meriwether: Welcome, everyone.
I'm Leh Meriwether and with me is Todd Orston. Todd and I are partners at the
law firm of Meriwether and Tharp and you're listening to the Meriwether and
Tharp Show. If you want to read more about us, you can always check us out
online at atlantadivorceteam.com.
Leh
Meriwether: Well, today we're
talking about business valuations. How do you deal with a business when the
parties are going through a divorce, because we do encounter those frequently,
and usually it's not an Amazon situation like when Jeff Bezos got a divorce.
Most commonly we see businesses that are earning anywhere from $100,000 to $10
million a year. I mean, we've dealt with some that earn a lot more than that,
but general speaking that's the most frequent that you see.
Todd
Orston: And look, the
interesting thing with businesses as with... The application of fuzzy math,
meaning you could talk to one attorney or one person and they could put a value
of something, of a dollar on a business, say, "Well, it really doesn't
have a lot of value." Yet you calculate the value in a different way and
it's worth $100,000. Those numbers can be depending on the type of company, it
could be, "Oh, the company's only worth a million dollars," but you
crunch the numbers a different way and it's like, "That's a $15 million
company." Then again we get into some of the issues we were talking about
before, where, "Okay, but I can't," if most of the value is tied into
the business, like let's say a construction company. That's great. We add up
all of the assets and I have dump trucks and bucket loaders and I have all this
other equipment. Great, it's worth $5 million. I want two and a half million
dollars. Okay, so that means I have to sell all of this equipment and then I
can't do the work, and basically the business is gone.
Leh
Meriwether: Right.
Todd
Orston: So there is so
many considerations that you need to, again, take into consideration. You need
to think about these things, and that's why it does get complicated and why
usually we want to bring somebody like Seth in to help us to approach it and
maybe look at it in different ways to help parties understand what the value
truly is.
Leh
Meriwether: Yeah, and there's
three approaches when you do a true business valuation. That's one of the
opinions a business valuator can give. They take three approaches, and then
from those three approaches usually they yield three different numbers, two of
which are very similar but the other one's often the lowest. That's the asset
approach. The three approaches are asset approach, income approach, and market
approach. Often, the income approach is close to the market approach, with some
exceptions, but the asset approach is typically the lowest. What's important
here, you'll see this sometimes, people will come in and go, they'll have their
tax return and say, "Well, my business isn't worth anything." Well,
and perhaps it's a dentist office that it's like a year old, and they spent
several hundred thousand, maybe $500,000 buying all this equipment, the nice
chairs, all this, and they for whatever reason under IRS guidelines, they were
able to depreciate all of it in the first year. I'm not saying that could
happen, but you never know when the tax laws are constantly changing. So the
book value of the business could have been at zero, because the book value is
the value on the tax return. That's what they dropped it at.
Leh
Meriwether: But from a
standpoint of an asset approach, that's not the true value. The asset approach
is what's the fair market value of that equipment? I mean, they may be able to
sell it for a quarter of a million dollars, so perhaps he hasn't started
earning any money with this business.
Todd
Orston: And that doesn't
work also with a lot of service-related companies. When you have a solo
practitioner or an attorney or you have a CPA or someone where it's really very
heavily based on services, and the equipment that they have is maybe a computer
and a chair and a desk. Okay, so my business is worth $24.22. But if they're
doing a whole bunch of business and if they are working in a way that basically
they have a lot of income or they have the ability to pass that business on to
someone else in some form or fashion, then clearly it's worth more than $24.00.
Leh
Meriwether: Right. In that
situation you would look at the income approach and the market approach,
because they'd have a far greater value there than the asset approach. That's
why you can't look at any one specific approach and say, "Okay, that's the
value," because it's so dramatically different. Now, probably a good point
to say, the market approach is often close to what that calculation of value
is. In fact, many of the business valuators I know, they have rules of thumb,
and when I say rules of thumb, they have access to sort of industry standards.
Seth actually shared some of his with us one time.
Leh
Meriwether: For instance, an
autobody repair shop. When you look at the industry standard, it's 25-35% of
their gross annual sales. And a bakery, 40-45% of their gross annual sales. An
accounting or tax practice, 100-135%. So he takes some information, applies
some of it to the rule of thumb, and comes up with the calculation of value,
not the true deep business value.
Todd
Orston: The analogy
would be sort of like with real property valuations. You'll go and you'll have
your house valued, and there are comps. When you look in the valuation report,
basically the appraisal, you're going to see some comps. Two, three, four five
comps. And that's what we're talking about. It is, "This is what other
similar homes have sold for in your area and therefore that's going to form at
least a part of the basis for the valuation of your home."
Leh
Meriwether: I'm glad you
brought up that analogy because-
Todd
Orston: You're welcome.
Leh
Meriwether: ... because that's
probably a good way to break down the differences between with the calculation
of value versus the business valuation. The calculation of value is like going
to a real estate agent and having a comparative market analysis. They're just
looking at the comps, but the real estate appraiser's going to go inside the
home, see its condition. I mean, there could be things falling apart, and
because of that, yeah, the comps pull it up, but then because all these repairs
need to be done it drops the price. So that's a good way to compare the
calculation of value versus the business valuation.
Leh
Meriwether: All right. So
let's talk about sometimes that market approach doesn't work. Perhaps the
bakery, it's got a million dollars in sales. So you apply the 40%, it's worth
$400,000. Well, not exactly, because I have $800,000 in debt. Well, that will
offset that valuation. The debt will offset the valuation, so you can't just
look at the market approach. All these factors come into play and it's really
fascinating.
Leh
Meriwether: Looking at the
income approach, here's a good example. Let's say you got a business and this
business has a net income, so after the business has paid everybody, it brings
in $120,000 or to the shareholder, the sole shareholder receives $120,000 in
net profit, and the sole shareholder's also an employee in the company but only
gets paid $5000. Well, if you've got, let's say it's an auto body shop or a
mechanic shop. Not an autobody shop but a mechanic shop. And the mechanic or
the owner happens to live in Florida but the shop is up here in Georgia. Well,
he's really not doing anything. Maybe he's doing a little bit of marketing or
managing the books and everything, so he pays himself a "salary" of
five grand. Well, if he's barely doing anything and he's bringing in $120,000,
under the income approach that business is very profitable. It has a high value
because he has to do very little for it to operate.
Leh
Meriwether: But if you take,
let's take going back to-
Todd
Orston: Owner operator.
Leh
Meriwether: Yeah, the
owner-operator. So he's barely doing anything but he's really got a manager in
there who's managing the day to day operations.
Todd Orston: But the alternative is that
you're going to get to is the person who is the owner operator, the one who's
actually on the ground doing the work and pulling the salary.
Leh
Meriwether: So let's use, I'm
going to change it now. Let's say it's a consulting business, and let's say in
this consulting business there was the woman that owns it, she prior to
starting this consulting business, she actually worked for let's say Deloitte
or some big consulting-type company, and she got paid $300,000 a year when she
was there, and now she's working this business. She's been in it for a few
years. She is busting her butt. She's working 80 hours a week. She's only paid
herself a "salary" of five grand but she still had profits of 120,
but when you add those two together you're looking at $125,000, which is a far
cry from the 300,000 she was earning. In that situation, that business really
isn't worth anything because the valuator's going to go in there and say,
"Okay, if I had to replace the business operator, if I had to pull her
out, maybe I wouldn't pay her replacement $300,000 because this consulting
company doesn't have the name of, like I said, Deloitte or something like that,
doesn't have that name, so she wouldn't earn $300,000, but $200,000."
Well, now under the income approach this business is upside down $75,000.
Hopefully I didn't get too technical there. Trying not to.
Todd
Orston: You can hope. No
harm in hoping.
Leh
Meriwether: But the reason, I
know I did go probably a little too deep there, but the point was to give an
example of how deep the lawyers can get with the help of a business valuator.
Because somebody may say, "My business is worth nothing," and they
may be right, or they're just saying that because they don't want to pay their
spouse anything. Up next we're going to talk, we're going to continue to dive
into how do you actually, once you figure out a value, how do you fairly split
it up?
Leh
Meriwether: Welcome, everyone.
I'm Leh Meriwether and with me is Todd Orston. Todd and I are partners at the
law firm of Meriwether and Tharp and you're listening to the Meriwether and
Tharp show. If you want to read more about us, you can always check us out
online, atlantadivorceteam.com.
Leh
Meriwether: Today we've been
getting into business valuations, and I'm trying not to go too deep. The
problem is in my head I just recently finished presenting at a seminar to other
lawyers about how do you deal with valuing a business inside the context of a
divorce, and then what do you do with it once you've given it a value. How do
you give the other spouse, perhaps you've got one that owns the business and
the other one that doesn't, how do you fairly pay that other person without
potentially causing the business to collapse?
Leh
Meriwether: But before we get
into that, how do we break up this, how do we deal with that fairness aspect,
we still wanted to cover a few more things with the valuation, because I'm sure
a lot of people have got questions.
Todd
Orston: I'm sure. I have
questions.
Leh
Meriwether: Oh, what are your
questions?
Todd
Orston: Inquiring minds
want to know.
Leh
Meriwether: You must have
missed my seminar.
Todd
Orston: Yes, I did
actually, and I'm sure it was fantastic. But let's talk about, we're scratching
the surface. For anybody and everybody listening, understand that it would be
almost impossible for us to do a full lesson on business valuations and do a
deep dive in terms of teaching all the ins and outs of business valuations. But
there are terms that anybody who is potentially thinking about a divorce or
thinking about anything where a business valuation is going to be an issue,
there are things you need to be aware of. There are terms and what have you
that you need to recognize, things like goodwill or discounts, valuation
discounts that need to be or can be considered. Let's jump into some of those.
Let's talk about those because I know you spent some time at the seminar
teaching on that. When I use words like goodwill or valuation discounts, what
am I talking about?
Leh
Meriwether: Let's hit goodwill
first. You've got goodwill, and that's really the difference between the asset
approach and the income and market approach. It's that sort of intangible
asset. Your assets are worth $100,000, but you're selling $5 million worth of
goods every year, so the difference is goodwill, meaning what is the value of
this business to the customers? So that's the goodwill. Then within that
goodwill, there's two different types of goodwill. There's personal goodwill
and enterprise goodwill.
Leh
Meriwether: Enterprise really
is associated with the business. In Georgia and Florida, the courts really only
look at enterprise goodwill. Personal goodwill is considered separate proper to
the person. A good example of personal goodwill might be a solo practice. When
I say solo practice, you've got a lawyer and it's just the lawyer and a
paralegal, and they have perhaps a divorce practice. Well, that entire divorce
practice is dependent on that lawyer and their personal goodwill and it's
really hard to put someone else in that place and take over. It's difficult. So
there's a high level of personal goodwill associated with that business. It
might have a tremendous amount of income, but if it's all associated with the
lawyer or 90% of it, there's going to be a 90% discount on the value of the
business. You take all these approaches, and you say, "Under these
approaches, it has a value, this business, this law practice, has a value of
$500,000." Then you have to multiple that times 10%, which would drop it down
to $50,000, and that's the value of the business for the consideration of the
divorce.
Todd
Orston: Yeah, and again,
in a divorce we're going to be talking about, there are a number of issues.
We're talking about property division. That doesn't change the fact that for
purposes of child support calculation, alimony calculation, if that person is
making $500,000 a year, that person's making $500,000 a year. We're talking
about how does the asset, the business, get divided, and what value is being
attributed to that asset?
Leh
Meriwether: Yeah. With most of
those law practices, there's some exceptions, but most of those law practices,
the personal goodwill is 99%.
Todd
Orston: Right, but as
opposed to, and I know this is where you were going to go, as opposed to let's
say a firm like ours. Okay, where the name has become something more than just
a single person. We are a bigger firm and therefore arguably someone else could
step in and become sort of enmeshed in the company and then take over the firm,
and Meriwether and Tharp is still Meriwether and Tharp. So even if you stepped
out, Bob stepped out, Bob Tharp, please don't. No, but the point is, you could
step out and it would still be Meriwether and Tharp, and the company itself,
the firm has value.
Leh
Meriwether: And some of the
other law firms, like King & Spalding is probably another good example.
Todd
Orston: That's right.
Leh
Meriwether: They do corporate
law and I think they represent the top 50 businesses in the the-
Todd
Orston: It's much bigger
than the two names.
Leh
Meriwether: And they've been
dead for a while, the King and the Spalding.
Todd
Orston: Which I hear
they're great in court now. Sorry, that was terrible. Anyway, the point is
well-taken, that it is King & Spalding, but it's not all about, of course,
King and Spalding.
Leh
Meriwether: Right, that's the
name now.
Todd
Orston: It is now a
business and the enterprise itself has value.
Leh
Meriwether: Yes. So the same
thing will apply to a lot of businesses. Use Dave Ramsey, for instance. Dave
Ramsey Solutions, it does sound like there would being a lot of personal
goodwill in that because he did start it. It was associated all with his name.
Todd
Orston: And there is an
aspect of personal goodwill.
Leh
Meriwether: Of course, but he
has now set up his business so that if he passes away, that business will keep
operating. Zig Ziglar is another example. His businesses continue to operate
even though he's been dead for several years. People tend to make too much,
there's a tendency to make too much issue about personal goodwill. I don't want
to get people too tied up, "Oh, the business, it's just me. You take me
out of the picture, it's gone." That's where the business valuator comes
in.
Todd
Orston: All right, so
let's now talk about what are valuation discounts?
Leh
Meriwether: All right, so a
lot of times you have a minority owner. Well, if it's a minority owner in Coca
Cola, you can sell your shares and it's no big deal, but when you have a
non-publicly traded small business, the minority owner, well, that means they
have a lack of control in that situation. They can't easily sell it because
that's a lack of marketability. So there's two discounts really that play into
this. It's the lack of control because they're a minority owner, and typically
there's discounts have given 15-30% there. So this says, all right, your
business, let's say you own 10% of a bakery and we valued that bakery as a
whole at $400,000. If both business owners went out and sold it tomorrow, the
smaller owner would get, the 10% owner would get $40,000. Well, but if they're
not doing that, because in the context of a divorce they're not doing that, you
can't just say, "Well, that small business owner, well, okay, it's 40
grand is its value and we're going to split that 50/50." No, because you
have to give them a minority discount.
Todd
Orston: And think of it
this way. It's going to be less appealing to a potential purchase who is going
to come into a bakery and say instead of, "Oh, I will buy the bakery and
now I control the bakery," you are able to sell let's say 10%. The market
is much smaller for somebody who is willing to, even if that opportunity
exists, to step into that business only to purchase 10% of the business. I'm
not saying it can't happen, but the market itself is much smaller. There are
fewer people that want to do it, thus the discount.
Leh
Meriwether: With that
particular discount, you can actually stack those discounts. On the lack of
control, the minority interest discount, let's say we put it at 30%. But then
we say, "There's a lack of marketability for this particular business and
we're going to put that at 20%," because it's between 20 and 25%. Now all
of a sudden you have a 50% discount, so the marital interest in this business
is $20,000, of which if you were to split that 50/50, then the husband, let's
say the husband owned the 10%, he was a baker, he only needs to pay her if
we're going to just do a cashout option, $10,000 out of the business and we've
split it. So that's where something, a business on the surface could look very
valuable. In fact, we've had people come in and say, "It's making a
million dollars. It must be worth $5 million." Well, no. Sometimes we
start with a rule of thumb. Well, if I look at the rule of thumb it's only 40%
of gross sales, so at best it's worth 400,000.
Todd
Orston: Then there are
marketability issues. There are discounts that have to apply. And keep in mind,
there are arguments against anything and everything, of course, but if you're
going into court and there's an expert on the other side who is doing this
analysis and it is accepted analysis for a business valuation, you're fighting
an uphill battle. So you just need to be aware of the terms that are going to
apply and the analysis that would be done and used in the context of a case.
Leh
Meriwether: And I really am
trying to do my best to keep this as simple as possible, but it still can get
complicated. We're going to talk about something else that's complicated up
next. We're going to get into dividing this up. We're going to get actually
creative, because I've had lots of cases involving businesses and because both
parties, for the most part they were getting along, even though we hadn't
settled the issue of the business, they were getting along, we got very
creative in coming up with a fair resolution on how to deal with that business
inside the divorce. We'll talk about that next.
Leh
Meriwether: Welcome, everyone.
I'm Leh Meriwether. With me is Todd Orston. Todd and I are partners at the law
firm of Meriwether and Tharp and you are listening to the Meriwether and Tharp
Show. If you want to read more about us, you can always check us out online,
atlantadivorceteam.com. If you want to see a transcript of the show or listen
to other shows, you can go to divorceteamradio.com, and there you can also find
links to subscribe to us in iTunes, Stitcher, SoundCloud, all those great
places.
Leh
Meriwether: Okay. Last part.
We have gone through, we have valuated the business. We're not going to get
into when you've got a contested case and you have two business valuers. Let's
say we've got the parties have agreed to the value of the business. What do you
do with it? There's lots of scenarios. We'll try to hit as many of them as we
can in this show. Let's first talk about where you got a owner and the spouse
who's not involved in the business at all. Let's say it has a value of $500,000
and if you were playing things out then perhaps he needs to pay if they've
agreed we're going to split everything 50/50, he needs to pay her $250,000.
Leh
Meriwether: Problem is,
there's not $250,000 in cash. One thing we do as lawyers is we'll look is there
someplace that we can balance this out. Now if we were representing the wife, a
nice way to balance it out would be to give, so let's say there's $250,000 in
equity on the home. Well, we'll say, "Well, she gets to keep the entire
equity in the home. He keeps the business." I'm sorry, you would have to
say there's $500,000 in equity in the home, sorry. Because he would have half
interest in that. So she keeps the entire home with $500,000 in equity because
they were smart during the course of their marriage and they paid off their
mortgage in its entirety so it's worth $500,000.
Todd
Orston: Well, it could
be 250, because if the business is 250 and the house is 250, arguably it would
be-
Leh
Meriwether: Well, no, if the
business is half a million.
Todd
Orston: Yeah, I know,
but if it was 125 and 125-
Leh
Meriwether: Oh, if it was
that.
Todd
Orston: Yeah. Then
basically what you're saying is if the business was 250 and the house was 250,
rather than splitting both of them, you keep the house, you keep the business.
Leh
Meriwether: And that's
actually more favorable to the wife because there's an exception to capital
gains tax when you're dealing with the residence you're living in [inaudible
00:35:30] real estate.
Todd
Orston: But there are
other considerations, because sometimes it may not be favorable because
sometimes, let's say it's retirement. Well, that's qualified accounts and it's
pretax dollars.
Leh Meriwether: Oh, you mean we're going to offset
the business with retirement.
Todd
Orston: Right, with
retirement. So a lot of the things we have to thing about, and where you end up
having to get creative is, okay, you're going to keep the business and the
business is income-producing and what have you, and all right, I'm going to
keep a 401K that I can't touch for 15 more years? Okay, well, that doesn't
really work for me because if I need to touch that money I am going to
basically have to deal with penalties and taxes or whatever. So if you just
gave me let's say dollar for dollar a $250,000 amount for the business and I'm
going to get 250 in extra 401K, well, that's going to be deeply reduced if I
even can draw down on that 250,000 in retirement because of the penalties and
the taxes.
Leh
Meriwether: Right, you're
taxed on normal income, whereas if you were to sell the business, he's taxed
based on capital gains.
Todd
Orston: That's right.
Leh
Meriwether: But when you're
talking about the house, if you're single you get a $250,000 exemption. There
is no tax, whereas he's getting taxed if he were to sell his business, he's
getting taxed and then depending on the income coming out of the business will
depend on what his capital gain treatment is, because it's anywhere from zero
to 20% and it can change tomorrow with a new change to the tax law.
Leh
Meriwether: So that's the
analysis that we work through to try to find something that's a fair way to
offset it with another asset, taking into consideration taxes. So that's one
thing. The other thing is there could be a payout over time. Well, the problem
with a payout over time is that perhaps the business, there's a problem with
the business in like our Great Recession, and all of a sudden he can't pay her
what he agreed to, but now it's a court order, and the court's like,
"Well, you can't bankrupt her. You owe her all this money. I understand
the business isn't making anything now, but you still have to pay it."
Todd
Orston: Yeah, unless
your attorney has done a good job working into the equation language that could
contemplate changes in the market or changes in the value of the business. If
there is a bankruptcy event, if there is something that basically could be
taken into consideration for a future modification.
Leh
Meriwether: Yeah, and I will
say though that most lawyers on the other side won't agree to that.
Todd
Orston: Absolutely, but
that's where it gets tricky. That's what I'm saying. The other side's going to
be like, "No, you're getting the business. You're going to reap the
rewards if you turn it from a one million to a $10 million business." Then
I don't care. If you turn it from a one million to a zero dollar business, I
still get my money because we're valuing it as of today's date.
Leh Meriwether: So the other option is to get
financing, because sometimes you can get that, and obviously if it goes under,
well, you'll get sued by the bank that loaned you the money, but you can file
for bankruptcy on that, whereas you can't bankrupt out of something arising out
of the divorce. There's options. Those are things that we have to work through,
and you just got to work through it when you got to get both parties in there
to think though, because you don't want to go in front of a judge with this,
because the judge doesn't have time to think through it and figure out
something that's fair and creative.
Todd
Orston: Right, and going
back to what I was saying before and what you commented on, you have to think.
I mean, we don't have crystal balls, but you have to think ahead. You need to.
If you're in a business that has been trending downward, then that needs to be
taken into consideration. If you're in a business that's trending upwards,
fantastic. Then good for you. But if it's been trending downwards-
Leh
Meriwether: Like a taxicab
company.
Todd
Orston: Yeah, that's
right. I've had clients come to me and they have a business and it's like,
"Well, three years ago I made $500,000 and two years ago I made $250,000
and last year I made $175,000." Okay, well, if we do a valuation right now
let's say the valuation came back at something based on $175,000 of income, but
if I'm now looking at a trend, next year's, is that going to be 100 and the
year after that it's even less? We need to take those things into account when
we're negotiating a settlement because we don't want you to lock into something
you can't afford.
Leh
Meriwether: Now, sometimes
you've got cases where both husband and wife work in the business. You've got
to decide are you both going to stay in the business.
Todd
Orston: Not a good idea.
Leh
Meriwether: Usually not, but I
had a case-
Todd
Orston: It has happened.
Leh
Meriwether: There was a case
years ago where they had a series of businesses. They were all the same. It was
a franchise. They had something like nine of them, 10 of them, and nine of them
were okay, but they decided they were just going to sell them and split them,
but there was one that was just killing it. It was outperforming any other in
the area, in the region, and they both decided, "You know what? We don't
want to give this up. We want to stay working in it." What we did was we
crafted a very, very, very detailed operating agreement. This thing was like 85
pages long, and it had all these different "if then, if this, then that,
if this." It took me forever.
Todd
Orston: You have to deal
with control issues. You have to deal with management and all those types of
issues.
Leh
Meriwether: How to deal with
disputes and how are we going to resolve them. It took me forever to put
together, but they both agreed to it. They were happy with it. They got
divorced, and they never had a problem that I'm aware of. I think they
eventually wound up selling that business, but they were able to operate in it
for a long time, reap the rewards of it.
Todd
Orston: And my comment's
not a good idea, that is usually the case.
Leh
Meriwether: I agree with you.
Todd
Orston: It's the same
thing that we say, "Well, we're going to live in the same house after the
divorce." No, maybe not. Maybe you shouldn't do that. It might work. I've
seen parties where they're still living together six months after a divorce and
they're making it work. Okay, then that's great, but on paper it's not a great
idea.
Leh
Meriwether: Yup. And most of
the time we counsel people not to do it.
Todd
Orston: That's right.
Leh
Meriwether: You've got to do a
very, you really have to gain clarity, going back to our last show.
Todd
Orston: Absolutely.
Leh
Meriwether: You need to gain
clarity as to whether this is a good idea, can you operate together.
Todd
Orston: And it will call
for a lot of, you said, maybe not an 85 page, like if you're living together in
the same home you don't need 85 pages of terms, but you're going to need a lot
more clarity and concise language so that when a problem or if a problem
arises, there is a clear way to handle it. That avoids you having to come back
to court and fight in court over something.
Leh
Meriwether: Well, the problem
is you can't come back. When you're in a divorce-
Todd
Orston: Division of
property issues.
Leh
Meriwether: ... in division of
property issues it's [inaudible 00:42:36]. You can't come back to court. You're
going to have to go to corporate court basically and boy, that can get even
messier than a divorce. Another way we've done this is we've had the business
split in two. Again, that created a very detailed breakdown of how they were
going to split those two businesses up, who was going to be responsible for
what. There was some shared marketing issues, so how do we deal with this phone
number. If someone calls in asking for X, Y, and Z how's it getting over to
Business B versus Business A, and is Business A going to steal business from B.
So that created a lot of effort to make that happen, but it did happen. They
were able to move on and both operate their own separate businesses and grow
them apart from each other.
Leh
Meriwether: Well,
unfortunately, we're out of time again. There's actually some other options,
but if you do have this situation and you definitely need to call an attorney,
this is not something you want to take on your own, because we'll help you with
the help of a business valuator figure out how to deal with the business in a
divorce. Thanks so much for listening.