How to Value a Professional Practice or Business in a Divorce

How to Value a Professional Practice or Business in a Divorce

Going through a divorce can be really tough, especially when it comes to figuring out how to divide up assets like a professional practice or business. As a business owner myself, I know how confusing and complicated this process can be. But having an accurate valuation of your practice or business is super important so that the division of assets is fair for both you and your spouse.

In this article, I want to walk you through the basics of how professional practices and businesses get valued in a divorce. I’m not a lawyer so definitely talk to your attorney about the specifics of your situation. But hopefully this gives you a good starting point for understanding what’s involved!

Why Valuation Matters

When a couple gets divorced, most states require that marital property (assets acquired during the marriage) get divided equitably between spouses. This includes the value of a professional practice or business started or acquired during the marriage.

Determining the value is important because it impacts who gets what in the divorce settlement. If the business is worth $1 million, should one spouse get the business and the other spouse get $1 million in other assets? Or should the business value get split, with each spouse getting $500,000 of the business value along with other assets?

Having an accurate valuation prevents one spouse from getting way more assets than the other. For most couples, the goal is a 50/50 split so the valuation process aims to determine a fair market value of the business.

When Valuation Happens

The valuation date is also really important. Most states use the date of separation or the date the divorce is filed as the valuation date. This prevents one spouse from artificially inflating or deflating the business value before the divorce is finalized.

It’s common for business owners to take actions to reduce profitability near the time of separation to make the business worth less. But the valuation will be based on the business state at separation, not after. It’s important to understand your state’s rules on this.

Who Does the Valuation

Figuring out the value of a business takes professional expertise. Most of the time, you’ll need to hire a professional business valuator to determine the fair market value of your practice or business.

Business valuators are accountants with additional training and certification in business valuation. They have the qualifications and experience to dig into the financials and operations of your business and come up with a defensible estimate of current fair market value.

Both spouses will likely need to hire their own valuators to come up with independent estimates. If the estimates differ significantly, the valuators may collaborate to come up with a joint recommendation. Or the court may need to get involved to determine the appropriate value.

How Valuation is Done

There are three main approaches business valuators use to estimate fair market value:

• Income approach – Estimates value based on the income or cash flows the business generates. This involves looking at past financials and projected future earnings.
• Asset approach – Totals up the value of business assets like real estate, equipment, inventory, accounts receivable, etc. and subtracts liabilities.
• Market approach – Compares the practice or business to sales of similar companies to estimate value.

For most professional practices like medical, dental, law, accounting, etc. the income approach is used. This involves detailed analysis of past earnings, overhead expenses, owner’s compensation, competition, growth projections, and more.

Adjustments are made to normalize earnings by removing any one-time or discretionary expenses. Things like owner’s perks and benefits get added back in to reflect market value vs. actual historical profit.

The valuator will apply multiples like 2-4x earnings to estimate a value. This method determines what a hypothetical buyer would pay to acquire the practice and generate similar earnings.

Factors That Impact Valuation

Many things can impact the valuation of a professional practice, including:

• – Customer base and retention rates
• – Strength of referral networks
• – Owner’s role and reputation
• – Staff and systems
• – Real estate and facility
• – Equipment and technology
• – Growth trends and profit margins
• – Competition and barriers to entry
• – Transferability of patients/clients
• – Recurring revenue
• – Brand identity

For some professions like medical and dental, the valuator will look at metrics like the number of patients seen, procedures performed, payer mix, appointment capacity, etc. Things that impact profitability and sustainability matter.

If the business is heavily dependent on the reputation and relationships of the owner, the valuation may be lower than a practice with strong staff, systems, and branding that’s less reliant on one person.

Adjustments and Discounts

It’s common for valuators to apply adjustments and discounts after determining a base value. These account for things like:

• – Lack of control/marketability if selling a minority interest
• – Limited transferability of patients/customers
• – Loss of key staff that may leave after sale
• – Above market owner’s compensation
• – Business transition costs

Discounts could reduce the valuation by 10-35%+ in some cases. It’s important to understand what discounts the valuator applies and why they are justified.

Other Valuation Challenges

Here are some other things that can make valuing a professional practice tricky:

• – Lack of comparable sale data for the profession
• – Comingling personal and business finances
• – Poor recordkeeping and financial controls
• – Owner perks like auto, meals, travel, club dues, etc.
• – Undocumented compensation arrangements
• – Unreported income or double books

Having organized tax returns, financial statements, agreements, and documentation helps the valuator do their job accurately. But they are trained to dig through messy situations and unwind things to get to a fair value.

Getting a Reliable Valuation

Here are some tips to getting a well-supported valuation of your professional practice or business:

• – Hire a qualified, experienced valuator, preferably with a designation like CPA/ABV
• – Provide several years of tax returns and financial statements
• – Share data on revenue, expenses, compensation, facilities, systems, staff, etc.
• – Explain any one-time or discretionary items
• – Note any major changes since the valuation date
• – Highlight strengths and weaknesses compared to competitors
• – Give examples of similar practices that have sold

A good valuator will interview you to fully understand the business. Don’t hold back information – the valuation needs to capture reality at the date of separation.

Be prepared to explain any aspects of the business that are unique or non-standard. The valuator’s job is to quantify everything relevant into a fair market value and valuation report.

If possible, try to agree with your spouse on using a single neutral valuator rather than dueling experts. This saves money and prevents very different estimates.

Also consider mediation to reach alignment on a valuation. Going to court over competing estimates gets very expensive and emotionally draining.

Closing Thoughts

Valuing a professional practice or business in a divorce is no fun. But having an accurate, well-supported estimate of value leads to a more equitable overall settlement.

Be thoughtful about who you hire as a valuator and provide them with quality information. Ask questions to understand how they arrive at their estimate.

And explore paths like mediation to get you and your spouse to an agreed-on value. This avoids an ugly battle of the experts in court.