Valuation of Businesses in Colorado Divorces

• Publication year: 2003
• Pages: 73

32 Colo.Law. 73 Colorado Lawyer 2003.

2003, June, Pg. 73. Valuation of Businesses in Colorado Divorces

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73

Vol. 32, No. 6, Pg. 73

The Colorado Lawyer
June 2003
Vol. 32, No. 6 [Page 73]

Specialty Law Columns
Family Law Newsletter
Valuation of Businesses in Colorado Divorces
by Robert W. Levis

This column is sponsored by the CBA Family Law Section to provide information to family law practitioners. Articles are intended to focus on practice tips and discussions of current issues within the realm of family law. New column authors are welcomed

Column Editors

Gretchen Aultman, Denver, of Burns, Wall, Smith &amp Mueller, P.C. - (303) 830-7000, gaultman@bwsm.com; Marie Avery Moses, Lone Tree, an associate at Gutterman, Griffiths & Powell, P.C. - (303) 858-8090, marmoses@msn.com

About The Author:

This month's article was written by Robert W. Levis, CPA, ASA, Colorado Springs, president and director of BiggsKofford Valuation & Litigation Services, LLC, a firm devoted exclusively to business valuations and litigation support consulting matters.
He specializes in business valuations, economic damage calculations, and forensic accounting matters in a litigation environment - (719) 579-9090, levis@BiggsKofford.com.

Valuation of business interests for Colorado divorce purposes must use the "standard" of value established by Colorado case law precedent: value to the marital estate or owner/spouse. This value may not necessarily reflect market value or value to those other than the existing
business owner.

Appraising business interests is a complex matter that requires expertise, experience, and a comprehensive understanding of the facts and circumstances surrounding the business interest subject to appraisal. Business valuations inherently involve a certain amount of subjectivity under any circumstances or for any purpose. Business valuation is sometimes referred to as an "art" or an "inexact science."

In the context of a Colorado divorce, the valuation of business interests often is more complex than a valuation performed for other purposes. In acquisition transactions, the buyer and seller negotiate a purchase and sale contract that allows tremendous flexibility in dealing with the inherent uncertainties and risks involved in transferring business interests. The terms of the transactions are structured to deal with the perceived risks. They include indemnification for breach of representations and warranties, hold-backs of a portion of the purchase price, non-compete agreements, earn-outs, and many other provisions. In business valuations for tax purposes, value is based on a fair market value standard,1 which has been clearly established by the U.S. Tax Court and is based on a hypothetical sale between a hypothetical buyer and seller.

In addressing the valuation of businesses in marital dissolutions, Colorado appellate courts have approved rulings by various trial courts that followed the valuation approaches and methodologies of testifying experts. The courts do not appear to have established any judicially preferred valuation approach or methodology. In marital dissolutions, significant latitude is afforded trial courts in adopting an expert's opinion where he or she has applied generally accepted business valuation theories and methodologies. Nonetheless, the expert is expected to appropriately take into account the specific facts and circumstances relevant to the business interest being valued and apply the appropriate standard of value.2

This article provides a basic overview of business appraisal theory and applications. The article also addresses many of the unique aspects of appraising business interests that may arise under Colorado marital dissolution law.

Business Valuation
Approaches and Methods

There are three generally accepted business valuation approaches that may be used when valuing a business. Each of the three approaches has several methods that may be applied in any valuation engagement. The quantity and quality of information available to the business valuation analyst, the facts and circumstances of the business interest being valued, and the appraiser's judgment are factors in selecting which methods should be applied in any given circumstance.

The three generally accepted approaches to valuing a business are as follows: (1) Asset-Based Approach; (2) Income Approach (including the Capitalization of Earnings Method); and (3) Market Approach. The popular Excess Earnings Method is a hybrid of the Asset-Based and Income Approaches, as discussed below. Some attorneys, CPAs, and business valuation professionals believe Colorado case law establishes preferences for certain methodologies, such as the Excess Earnings Method, and prohibits discounts for minority interests or marketability in marital dissolutions. However, such a belief is not conclusive.3

A properly performed appraisal will consider at least one method under each of the generally accepted appraisal approaches and "reconcile" the value indications of each business valuation method with a final opinion of value. This reconciliation analysis is a critical cross-checking process for the business valuation analyst. Significantly disparate value indications under various methods require the appraiser to revisit assumptions and calculations and to ensure that the reasons for such differences can be reasonably explained. Below is a brief discussion of each of the approaches used to appraise a business.

Asset-Based Approach

Under the Asset-Based Approach, the value of the business is reflected in the value of its individual assets less its liabilities. Note that "value" typically does not infer "book value" or the value of assets and liabilities on the business's financial statements or tax returns. Instead, the assets and liabilities of the business are individually appraised, usually with a Market Approach method (see below). The Asset-Based Approach generally is appropriate for a business where there is not a significant amount of income relative to the net assets of the company. This method is most relevant when there is little or no goodwill.

Income Approach and
Capitalization of
Earnings Method

Under the Income Approach, value is the present value of future benefit expectations - namely, income. It is the most theoretically sound of the valuation approaches where future "normalized" income expectations are converted to value using an "investor" required rate of return. The investor rate of return reflects the risks associated with the income stream subject to capitalization.

For marital dissolution purposes, the most commonly applied...