Sole Proprietorships should be very straightforward in a divorce mediation. In most cases, the business itself has no inherent value without the owner..
Categorizing Business Assets
When evaluating a sole proprietorship in mediation, business assets can generally be divided into two categories:
Assets necessary to generate business income
Assets owned by the business that are not required to generate income.
It would be unfair to allocate 50% of the assets essential to running a small business while simultaneously expecting its income stream to continue unchanged (for purposes of calculating spousal maintenance and child support). This is sometimes referred to as "double-dipping."
A Fictional Example: Walt the Electrician
Let's consider a fictional electrician named Walt who operates as a sole proprietor:
Walt earns $125,000 per year from his work as an electrician. He does all the work and does not have any employees or helpers.
He recently purchased a new truck for $65,000 (after a $5,000 trade-in) with a $25,000 loan on it.
He owns tools and equipment that he estimates to be worth $20,000.
Through his business, he recently purchased a home for $250,000 (with no mortgage) that he plans to remodel and sell.
The business has a checking account with $10,000 in cash.
Walt's business also covers some personal expenses including:
$5,000 in family travel annually
$1,000 per year for the family's cell phones
$500 per month lease for a personal vehicle. (Shhh! Don't tell the IRS!)
Evaluating Income and Business Assets
When assessing Walt’s income, it is typically considered before deducting personal expenses. Any personal expenses covered by the business should be added back to determine his actual income.
To value Walt’s business, it's important to recognize that without him, the business has no intrinsic value. The term "going concern value" refers to a business's ability to generate future profits indefinitely. However, in Walt’s case, without him, there is no business—so there is no going concern value. Instead, we must evaluate the business solely based on its assets.
Categorizing Walt's Assets
The $250,000 house is not needed to generate Walt’s income, so it should be classified as a business asset not required for income generation.
The $20,000 in tools are necessary for Walt’s work and have long-term utility. These should not be considered a business asset but rather essential equipment for generating income.
The truck is required for work, but its valuation needs careful consideration.
Accounting for the Truck
The truck presents an interesting issue. If we simply classify it as an asset necessary for income generation, we risk distorting the financial picture.
Consider Walt’s financial position before and after purchasing the truck:
Before the purchase: He had his old truck, an additional $40,000 in cash, and no loan.
After the purchase: He now has a $70,000 truck, a $25,000 loan, and $40,000 less in cash.
If we exclude the truck from the business assets category entirely, it artificially reduces business value by $65,000 in a single day.
So what's a solution? I would suggest treating the van as a business asset not required to generate income and reducing his income by a reasonable amount for truck usage. For example, let's assume his $70,000 truck will last 10 years. We can reduce his income by $7,000 per year and include the truck on the list of business assets. Here is what that might look like:
Asset or Liability | Value |
---|---|
Truck | $70,000 |
Truck loan | ($25,000) |
House to remodel | $250,000 |
Checking account (cash) | $10,000 |
TOTAL BUSINESS ASSETS NOT REQUIRED TO GENERATE INCOME | $305,000 |
Business income per tax return | $125,000 |
Adjustment for annual truck cost | ($7,000) |
Personal expenses add-backs | $5,600 |
Walt's Adjusted Income | $123,600 |
Final Thoughts This fictional example illustrates key concepts in valuing a sole proprietorship during divorce mediation. However, every case is unique, and how you approach these issues in mediation is ultimately up to you.
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.