When a partner in a small- or medium-sized closely-held business is involved in a divorce mediation, valuation becomes even more complex. The business is likely owned with multiple other partners and has many employees. Unlike sole proprietorships or small businesses with only a handful of employees, these businesses often have substantial assets, structured ownership agreements, and significant enterprise value beyond the individual owner's labor.
A key challenge in mediation is determining what portion of the business is marital property and how to handle its valuation in a fair and practical way.
Key Factors in Valuing a Closely Held Business
To properly assess a closely held business in mediation, it’s important to consider:
Ownership Structure:
Is the spouse a sole or majority owner, or do they hold a minority stake?
Are there multiple partners or shareholders?
Are there operating agreements or shareholder agreements that dictate buyout terms or otherwise limit owners?
Financial Performance:
Revenue, income, and long-term profitability trends.
Are profits reinvested in the business, or are they distributed to owners?
Business Assets & Liabilities:
Physical assets: real estate, equipment, inventory, and cash reserves.
Intangible assets: goodwill, brand reputation, patents, and customer contracts.
Outstanding liabilities such as loans, leases, or pending lawsuits.
Marketability & Transferability:
Can the business be sold or transferred?
Does the ownership agreement restrict buyouts or require partner approval?
Owner’s Compensation & Perks:
Is the spouse’s salary reflective of fair market value?
Are personal expenses covered by the business (e.g., travel, vehicles, club memberships)?
A Fictional Example: GreenTech Solutions, Inc.
To illustrate these concepts, let’s consider a fictional company, GreenTech Solutions, Inc., and one of its owners, James.
Business Overview:
GreenTech is a privately held technology firm specializing in sustainable energy solutions.
The company has 300 employees and generates $75 million in annual revenue with $10 million in EBITDA ("Earnings Before Interest, Taxes, Depreciation, and Amortization").
It owns $15 million in business assets, including office buildings, equipment, and patents.
Ownership Structure:
GreenTech has four partners, each holding 25% ownership.
The company’s operating agreement restricts ownership transfers, requiring partners to approve any buyout.
James’s 25% stake entitles him to a quarter share of net profits and voting rights.
James’s Compensation:
Base salary: $400,000 per year
Annual profit distributions: $750,000
Business-paid expenses: $50,000 (private club membership, company vehicle, travel, etc.)
Determining Business Value
Because GreenTech is a thriving company with multiple owners, valuing James’s 25% stake requires a different approach than valuing a sole proprietorship.
1. Asset-Based Valuation
The company’s assets and liabilities are calculated as follows:
Business Assets | Value |
Equipment, Real Estate & Patents | $15,000,000 |
Cash Reserves | $5,000,000 |
Total Assets | $20,000,000 |
Liabilities | Value |
Business Loans & Debts | ($3,000,000) |
Net Asset Value | $17,000,000 |
James’s 25% ownership stake, based purely on assets, would be valued at $17,000,000 × 25% = $4,250,000. However, most businesses are worth more than just their net assets due to their ability to generate ongoing profits.
2. Earnings-Based Valuation
Another approach is applying a valuation multiple to the company’s annual profits. Let's assume:
GreenTech has EBITDA of $10 million
Similar companies sell for 5x EBITDA
This indicates an enterprise value of $50 million ($10 million x 5), and an equity value of $47 million ($50m EV - $3 million in debt = $47m equity value).
James’s 25% stake would then be worth: $47,000,000 × 25% = $11,750,000. This is significantly higher than the asset-based valuation of $4.25 million, highlighting the importance of using multiple valuation methods.
3. Minority Discount Considerations
Since James does not have full control over GreenTech, his ownership share may be subject to a "minority discount" in valuation. This discount, typically ranging from 10% to 30%, reflects the reduced marketability and control of a minority stake.
If we apply a 20% discount to James’s $12.5 million share, his adjusted valuation is:
$11,750,000 × 80% = $9,400,000. Thus, James’s equity could fall between $4.25 million (asset-based) and $9.4 million (earnings-based, with a discount).
Handling James’s Ownership in Divorce Mediation
Once James’s stake is valued, the next challenge is determining how it factors into asset division. Since GreenTech does not allow ownership transfers without partner approval, directly dividing James’s 25% stake may not be an option.
Potential Solutions:
Buyout with Other Marital Assets:
James could retain his business interest while his spouse receives other high-value marital assets (e.g., real estate, retirement funds).
Structured Payout Over Time:
If an immediate buyout isn’t feasible, James’s spouse could receive installment payments over several years.
Profit-Sharing Agreement:
Instead of an outright buyout, James could agree to pay a portion of his business distributions to his spouse for a set period.
Valuation Adjustments for Spousal and Child Support:
If James’s salary is above or below industry norms, his true income might be adjusted to reflect a more accurate earning capacity.
Any personal expenses paid by the business (e.g., club memberships, travel) should be added back to his income for support calculations.
Final Thoughts
Valuing a closely held business for divorce purposes requires a nuanced approach that considers both tangible assets and future earning potential. Because ownership in such businesses often comes with transfer restrictions and minority discounts, a straightforward 50/50 split is rarely feasible.
By using a combination of asset-based, earnings-based, and market valuation methods, and considering the business’s operating agreements, mediation can lead to a fair and practical resolution that preserves business continuity while ensuring a just outcome for both spouses.
IMPORTANT NOTE: This post reflects the opinion of the author relating to fairly evaluating net assets and income during the mediation process. It is not legal advice nor is it an indication of what a court may or may not order. Consult your attorney for legal advice.