Orange County – Divorce for Business Owners and Professionals
Business owners and professionals face unique financial issues during an Orange County divorce that require a skilled divorce attorney with specific experience in handling complex and high-asset divorces. If you find yourself in this position, turn to divorce attorneys who have experience with executing creative and strategic solutions designed to meet your goals and resolve your case.
With 19 divorce attorneys whose exclusive focus is Orange County family law, the team at Minyard Morris provides its clients with a comprehensive approach and collaborative culture combined with unparalleled experience and knowledge in the area of complex divorces. This singular focus and team effort allows each of our attorneys to find effective and creative approaches for resolving complex issues for high-level professionals and business owners whether in a high net worth divorce or a more traditional divorce.
Orange County Divorce Involving A Business
Complex and Nuanced Issues
Whether your Orange County divorce is a high net worth divorce or a more traditional divorce, if it involves a business, then you will need a skilled and experienced attorney to navigate what can be one of the most complex areas of family law. Handling these matters requires a working knowledge of many issues which are not involved in the more traditional divorce. Not only is this area of law complex, oftentimes a business can be the most valuable asset at issue in a divorce – so it requires the skill of an experienced divorce lawyer and forensic accountant who are familiar with the related issues.
Our more than 46 years of experience handling Orange County family law matter have resulted in our firm being involved in countless cases involving business interests of all types. We understand that no two businesses are alike but having the breadth of experience in this sub-specialty gives us a huge advantage that our clients can take advantage of. Every business is different just like every client is different. Our firm’s team has unequalled experience and skill to recognize the nuances of the valuation of different types of businesses.
Why An Expert Is Critical
The importance of the role played by a forensic accountant cannot be over-emphasized. Experts generally assist with the valuation and characterization of a business but can do much more depending on the needs of a case. The forensic accountant should be retained as early as possible to assist with informed early settlement discussions, general case strategy, and, most importantly, so that they have ample time to prepare a thorough analysis for any hearings or trials. If your divorce lawyer waits months to retain the needed expert, you need to find out why. We retain experts on day one of the representation for many reasons. We want to use the expert to properly prepare the case, assist in developing the strategy and we want to make sure we hire the best expert for the business before the other side does.
Can You Avoid Hiring an Expert to Value a Business in an Orange County Divorce?
Can you avoid hiring an expert to value a business in an Orange County divorce? The answer is absolutely-YES!
You may not want to retain a valuation expert because you don’t want to delay the resolution of the case. You may just want “it over.” After it is “over” will you regret having left potentially significant dollars on the table? Make sure you have thought this issue through.
The question is: if you don’t hire an expert, who benefits? You or your spouse? The likely winner will be the party who is most familiar with the business and valuation issues. Generally, but not always, that is the operating spouse. Even though, you are not required to hire an expert to value a business in an Orange County divorce, you need to ask yourself, if you don’t hire an expert how much could you be losing by not knowing the actual value of the business?
Interestingly, there are occasions where the operating spouse overvalues the business because of his or her emotional attachment to his or her “baby.” This same result occurs relative to people attempting to value their homes or their boats. Emotions can certainly cloud judgment regarding everything, including the value of a business.
Parties may agree to value a business at any value they choose in a mediated or a litigated divorce. Understandably, people going through a divorce have a desire to minimize expenditures on attorney fees and expert fees. Who wants to spend money, any money, on a divorce? The question that should be asked is whether it is penny wise and pound foolish to not hire a valuation expert to save money. The cost benefit analysis requires determining how much a valuation will cost versus what is the probable range of values of the business as compared to the value of the business that is being proposed.
If you are considering resolving your Orange County divorce without the assistance of a valuation expert, how do you know that your spouse has not consulted with an expert without telling you? Just because your spouse says that he or she has not retained a valuation expert does not mean that statement is true.
At a minimum, due diligence dictates meeting with an expert to have a “drive by” two-hour discussion about the valuation. The expert that your lawyer has recommended may have a fee that you do not want to pay. An alternative is to consult with an expert who is less experienced and less expensive than the preferred expert. A less qualified expert is better than no expert.
How is a Business Valued in an Orange County Divorce
Whether you have a high net worth divorce or a more traditional divorce, and whether a business is found to be separate property or community property, a thorough valuation by a forensic accountant is generally necessary. The measure of value is typically investment value. The valuation method may be determined by a number of different formulas, so long as they do not involve speculation, and do not violate any family law principles.
The two most common valuation methods accepted in the Orange County family law courts are the Capitalization of Earnings and Capitalization of Excess Earnings. The objective is to determine what portion of the revenue is attributable to the services of the owner-spouse as opposed to the business itself.
A business is often not valued in a divorce in the same manner as it is valued for sale purposes. For sale purposes one of key methods of valuation is Discounted Cash Flow (DCF). In family law, the Orange County family law courts do not look to future revenue but rather analyze the past financial performance of the business.
The likely value on a sale of a business is not irrelevant but it is not the test of value because the business is not being sold. The owner-spouse will continue to operate the business so the value is based on the value as an ongoing investment. Since there will be no sale, there will be no capital gains tax, no commissions, no earn out, no covenant not to compete, no employment contract, etc.
When determining valuation, an expert will usually look at the business’s financial performance over the past five years. However, certain years may be omitted if they contain events that are non-recurring and their use would result in a less accurate view of the financial performance of the business.
When is a Business Valued in an Orange County Divorce
Generally, a business is valued as close to the date of settlement or trial as is reasonably practical. There are exceptions to this rule. Under some circumstances, a business may be valued on the date of separation or other alternate valuation dates or the date most practical relative to that date. The businesses that are valued at the date of separation are generally businesses where the operator-spouse is the dominant primary driver of the business revenue. Classic examples of a date of separation valuation would be a solo practice lawyer, doctor or accountant. Other small businesses may also be candidates for a date of separation valuation. The theory that supports the date of separation valuation is based on the family law principle that a person’s earnings after separation are their separation property. If the earnings of the business are essentially the earnings of the owner-operator spouse then the performance of the business after the date of separation are attributable to the work, effort and skill of the owner-operator spouse and are thus that person’s separate property.
A business may also be valued at the date of separation if an event occurred after the date of separation that decreased the value of the business and the event was an intentional or grossly negligent act on the part of the operator-spouse.
How is the Character of a Business Determined in an Orange County Divorce
Generally, the characterization of a business is determined by the date of its acquisition. If the business was purchased or founded before the marriage, it will be characterized as the separate property of the owning spouse. If a business was founded or purchased during the marriage, it will likely be characterized as community property. Of course, if it was purchased with one person’s separate property it may be characterized as that person’s separate property.
Regardless of how much the business increases in value during the marriage, if it was founded or purchased before the date of marriage, it will remain the separate property of the owning spouse. The other spouse cannot gain an ownership interest in the business. However, it is possible that the community may be entitled to a right of reimbursement for a portion of the increase in the value of the business during the marriage depending on a number of factors.
How Is the Value of the Business Apportioned in an Orange County Divorce
If a separate property business is at issue, then the court will look at whether there was an increase in the value of the business during marriage. If so, the court will then determine whether to reimburse the community for a portion of the increase in the value during the marriage. There are two approaches most commonly used by the courts in conducting this analysis that differ based on whether the increase in value was or was not the result of the operating spouse’s efforts during marriage as opposed to other factors. Whether the business is capital intensive or service oriented is very important to the determination as to which formula is used.
Under the Periera approach, the business is valued as of the date of marriage, the owner-spouse is awarded that value plus a reasonable rate of return on that value (7% to 10%, compound or simple interest) and the remaining portion of the value is reimbursed to the community. In other words, the owner-spouse will be required to pay the other spouse a sum equal to half of the portion of the increase in value of the business during the marriage that exceeds the rate of return on the value that existed on the date of the marriage. This approach is often applied when the business is service oriented and generally favors the community over the separate property.
Under the Van Camp approach, the owner-spouse’s compensation during the marriage is analyzed and if the compensation was adequate and reasonable then the community is not entitled to any right to reimbursement. The theory that supports this analysis is that the community was made whole by virtue of the receipt of the compensation. If the court finds that the owner-spouse was under-compensated, the community is entitled to be reimbursed for the amount of under-compensation. This approach is often applied where the business is capital intensive and generally favors the business operator and his separate estate.
Regardless of whether a divorce is a high net worth divorce or a more traditional divorce and regardless of whether the business is a high value asset or a more modestly valued asset, the same principles and laws apply to the apportionment of a business.
How is the Value of a Business Equalized in an Orange County Divorce
If a community property business is at issue, each spouse is typically entitled to half of its value. In other words, the business is valued and the spouse who Is not awarded the business will be awarded assets whose value equals the value of the business itself or the spouse who is awarded the business will be ordered to pay the other party a sum equal to half of the value of the business.
Courts generally do not order the operator-spouse to borrow money to pay the equalization payment. Most often, the equalization payment will be paid over a three-to-ten-year period, will bear a reasonable rate of interest and will be secured if practical. The term of the equalization note is often driven by practicality. The revenue of the business will dictate the amount that can be paid monthly or annually to the other spouse as an equilizer.
Who is Awarded the Business in an Orange County Divorce
If the business is community property, and there are no unique circumstances, the business will typically be awarded to the operating spouse. If both parties operated the business together and each wants it awarded to them, it is generally awarded to the party that is most critical to the continued success of the business. It is rare for an Orange County family law court to award a business jointly to the parties. Joint ownership of a business by two divorced people is essentially guarded future litigation. Of course, if parties both desire to own the business jointly after the divorce, the family law court will not object. If the business is the separate property of one spouse, it is awarded to that spouse. Whether a business is separate property or community property, it is rare for a business to be ordered sold by an Orange County family law court.
Lawyers, Doctors, Accountants And Other Professionals
Intricate and Nuanced Issues
Like in a divorce involving any business generally, where a divorce involves a private practice, a skilled and experienced attorney is necessary to navigate what can be one of the most complex areas of a high net worth divorce. Handling these matters requires a working knowledge of valuation, taxation, compensation, accounting, business structure, and relevant valuation statutes and case laws.
While a thorough analysis is needed in any divorce involving a private practice, some of the issues are generally summarized below. However, by no means should the factors listed be considered the entirety of the analysis. Private practice cases often involve perks, goodwill, contingency fees, accounts payable and receivable, depreciation, liabilities, equipment, operating v. non-operating assets, cash flow, valuation of intellectual property, reasonable compensation, working capital needs, partnership agreements, buy/sell agreements, and many other issues.
Our more than 46 years of handling divorces involving professionals in Orange County has given us the experience necessary to understand the nuances of the valuations of private practices. We provide an informed and tailored analysis of each private practice involved in our Orange County divorces.
Why a Forensic Accountant is Critical in an Orange County Divorce
The importance of the role played by a forensic accountant cannot be over-emphasized. Experts generally assist with the valuation and characterization of private practices whether in a high net worth divorce or in a more traditional divorce but can do much more depending on the issues of the Orange County divorce. The experts should be retained as early as possible to assist with settlement, case strategy, and, most importantly, so the experts will they have ample time to prepare a thorough analysis and be prepared for any depositions, settlement discussions or hearings.
As with divorce lawyers, all valuation experts are not created equal. It is difficult to quantify the value of the right experts in a divorce. The reputation of an expert is critical to the weight given to an expert by the Orange County family law court, the opposing lawyer and the opposing expert. An unqualified expert may not qualify as an expert at trial, which would prevent them from testifying. Such a result could be devastating to the outcome of the divorce, as the lawyer would not be able to present evidence of the valuation of the private practice to the court. For this and other reasons, we cannot use a client’s personal accountant in this role.
How is a Private Practice Valued in an Orange County Divorce
Whether a private practice is found to be separate property or community property, a thorough valuation by a forensic accountant is critical. The valuation may use several different methods, so long as they do not involve speculation.
The value of a private practice may also include goodwill. Goodwill is defined as the expectation of future patronage or the likelihood that the business will continue to attract clients. If goodwill is found to exist, the following factors may be considered in valuing it: the number of clients; the operator’s age, health, past earnings, professional reputation; how long the business has existed; customer retention and many other factors. The Orange County family law court has broad discretion in valuing goodwill and its determination will be upheld on appeal if it is within the range of evidence presented.
When determining the value of a private practice, an expert will usually look at the private practice’s financial performance over the past five years. However, an expert may omit or variably weigh certain years if they include events that are non-recurring that significantly impact revenue upward or downward.
When is a Private Practice Valued
There is a specific family code section and extensive case law that addresses the date of valuation. Private practices may be valued as close to the date of settlement or trial as is reasonably practical. There are exceptions to this rule. If the private practice is operated by the professional spouse and the revenue is primarily generated by that spouse, the valuation may be as of the date of separation.
How Do You Characterization a Private Practice in an Orange County Divorce
The characterization of private practices is determined by the date of acquisition. Was the private practice founded before marriage or during the marriage? If the private practice was founded before marriage, it is separate property of the founding spouse. If a private practice was founded during the marriage, generally it is community property.
How is the Value of the Private Practice Apportioned
If a separate property private practice is at issue, then the court will look at whether there was an increase in the value of the private practice during marriage. If so, the Orange County family law court will then determine whether to reimburse the community for a portion of the increase in value of the practice. There are two approaches commonly used by the courts in conducting this analysis. One of the key issues is whether the increase in value was or was not the result of the operating spouse’s efforts during marriage. Generally, the apportionment is analyzed under the Pereira approach in a private practice is a service-oriented business.
Who is Awarded the Private Practice
If the practice is a community property private practice, and there are no unique circumstances, it is typically awarded to the operating spouse. If both parties operated the private practice together, each is licensed, and each request that the practice be awarded to them, it is generally given to the party that is most critical to its continued success of the practice. If the practice is the separate property of one spouse, it will be awarded to the founding spouse. It is rare for a private practice to be ordered sold by the court.
Issues Related To Law Practices In Orange County Divorces
Minyard Morris is the law firm that lawyers retain to represent them in family law matters. Over its 46 years, Minyard Morris has represented countless lawyers. Like any business there are many nuances to valuing a law practices. Lawyers in private practice face different issues than do lawyers who are partners in large firms. Of course, lawyers who are W-2 employees are not owners and do not have to deal with valuation issues.
The private practice of a lawyer is generally valued using the capitalization of income and the capitalization of excess earnings methods of valuation. These different but related methods are generally accepted in the Orange County family law courts. Generally, the value of a private practice, like other businesses, is made up of two components: adjusted book value and goodwill. Most law practices do not have a substantial adjusted book value. Book value is comprised of accounts receivable, work in process, accounts payable, cash, computers furniture, etc. and is the value of the assets as it is represented on the financial statement of the business less liabilities. Adjusted book value is the actual value of the assets which may be higher or lower than the value of the assets as listed on the financial statements. The largest asset in this category is often the accounts receivable which often contain uncollectable receivables that need to be addressed. Goodwill is defined as the expectation of future patronage or the likelihood that the reputation of the firm will generate future referrals. Goodwill must be addressed in the valuation but the value may be minimal depending on the nature of the practice. If no goodwill exists, an ‘in place’ value may be added to the adjusted book value of the practice to arrive at the total value of the private practice.
The ‘in place’ value is an intangible value of a business that does not have goodwill and is used to address issues like the fact that there is an ongoing business, it has a telephone number, it has some clients or customers, it has some revenue, it is has an operation and there would be a cost to create what actually does exist.
If a lawyer is a partner in a large firm, the lawyer has signed a partnership agreement and most likely the lawyer has no interest in the assets of the firm. Assuming that many lawyers have joined and left the firm over the years and the terms of the buy sell agreement have been followed, the Orange County family law court will most likely follow the holding in Marriage of Iredale and Cates (2004) 121 Cal. App. 4th 321, which provides that the partner in such a firm is not an owner of the firm’s assets and does not own any portion of the firm’s goodwill. However, there may be an issue of relative to the personal goodwill of the lawyer.
The valuation date of a small private practice may be the date of separation. A private practice with many employees may be valued at the date of settlement or trial. This issue relates to whether the lawyer is the primary driving source of the firm’s revenue and a determination of the amount of revenue generated by others or the business itself.
Valuing A Medical Practice In An Orange County Divorce
Whether in a high net worth divorce or a more traditional divorce, valuing a medical practice in an Orange County divorce is both an art and a science. The experts who value medical practices have significant discretion in arriving at a value and for that reason, the experts rarely agree. The valuation process has similarities to valuing other professional practices but there are nuances. The value arrived at for a medical practice in family law is most likely not the same value as the practice would have on the open market. The value of the practice in a divorce is likely not fair market value in that the practice is not being sold. The value is the investment value which is the value of the practice as an investment to the physician on an ongoing basis. As with other practices, an expert is required to complete the analysis and the valuation. The value of a practice is a combination of the adjusted book value and the goodwill. Book value (assets less liabilities) is the value that the practice’s assets are represented to be on the financial statements. This book value is, most likely, not the actual fair market value of the assets. To arrive at the adjusted book value, the value of the assets must be adjusted to true fair market value. In other words, an asset may be fulling depreciated and reflected on the financial state has having no value when in reality it is still being used on a daily basis and has substantial value. In that the practice, most likely uses the cash method of accounting and not the accrual method, the accounts receivables are not listed as assets on the financial statements. The collectible receivables need to be added to the fair market value of the other assets to arrive at the total adjusted book value.
Accounts receivable often present significant problems in the valuation process. The uncollectible receivables need to be deleted. There may be a question as to what receivables are actually not collectible. If there is a dispute on collectability there may conflict as to how to address the dispute. There may be an issue as to whether the value of the accounts receivables shall be valued after tax or before tax. An inherent inequity relative to the receivables is the fact that the physician will have to pay the spouse for half of the value of the collectible receivables and then pay support using his or her share of the receivables after paying the tax. This is referred to as two or three bites of the apple.
Goodwill is the expectation of future patronage and is generally the most significant source of disagreement between experts. The determination of the value of goodwill includes the analysis of a number of issues including but not limited to the following:
- Age of the physician
- Location of the practice
- Profitability of the practice
- Condition of the premises
- Quality of the staff
- Type of services provided
- Stability and growth of the revenue stream
- Patient mix
The practice will likely be valued using the capitalization of earnings (earnings approach) and/or the capitalization of excess earnings method (asset approach). The experts will generally do the analysis using both of these methods and sometimes, assign different weights to each. In completing their analysis the expert, among other things, will have to determine the adjusted book value, the reasonable compensation for the physician, a rate of return on assets, a cap rate, and determine controllable cashflow. Simply stated, controllable cashflow is a combination of the W-2 earnings, any distributions and personal expenses paid by the practice for the physician.
A divorce involving a stockbroker or a wealth advisor now brings unique issues to a divorce that did not exist before the relatively new case of In re Marriage of Finby (2014) 222 CAL.APP. 4TH 977. The Orange County Family law court in Finby held that there could be a value to a stockbroker’s/wealthy advisor’s “Book of Business.” In other words, the court may characterize a “Book of Business” as an asset in the divorce. If a court values a “Book of Business” at $1,000,000, the stockbroker/wealth advisor would be required to pay his spouse 50% of that sum or $500,000 in after tax dollars. The Finby court did not find that there was a value but rather that there could be a value. The court did not provide detailed instructions as to how to determine if there was a value or how to calculate the value if one existed. Litigants are left to speculate as to what an Orange County divorce court or the appellate court will affirm or reverse relative to the value of a book of business and the methodology used to determine the value.
Some large brokerages pay brokers/wealth advisors to move their “book of business” to the new firm. The payment is in the form of a loan forgivable over a three to eleven year period. The amount of the loan relates to the unique characteristics of a ‘book of business’ in question and how the brokerage evaluates the future profit it will earn on a “Book of Business.”
The forgivable loan may be called if the stockbroker/ wealth advisor is no longer employed by the brokerage or if he or she fails to meet the performance requirements. Any debt forgiveness is taxable and results in a 1099 being issued to the stockbroker/ wealth advisor. In other words, the individual will have phantom income in the year of any debt forgiveness. He or she will pay tax on income they did not receive in that year.
The valuation may be based on a capitalization of earnings approach or a rule of thumb approach, both of which have theoretical deficiencies. The rule of thumb approach may value a “book of business” at a multiple of one to four times the trialing 12 months of qualified earnings. A valuation should address a number of potential discounts; tax on the debt forgiveness, risk that the loan will have to be repaid, compensation to a junior associate to monitor the book, etc.
Venture Capital Funds/ Private Equity In Orange County Divorces
Our lawyers have represented partners in venture capital funds and private equity funds. Partners in these funds generally own interests in the companies into which the funds invest their client’s money, called portfolio companies. The investment may be a result of the fund investing its own money or a result of a partner investing his money individually.
A partner may also share in the carried interest called “the carry.” The carry is a share of the profits of an investment paid to the fund who manages the investment. The carry is a performance fee, paying the fund for enhancing performance and is not taxed as ordinary income. The amount of the carry varies with the type of investment and with the specific venture fund. The carry may vary from 15% to 44%. The most common percentage is 20%.
The actual formula for distribution of funds from investments varies but a common formula is 1) return invested principal to investors and the fund; 2) pay investors their “preferred return” or “hurdle rate” which is typically 6% to 9%; and 3) allocate the remaining distributions 20% (carry) to the manager and 80% to the investors.
The investments made during the marriage in these funds are community property. There may be a question of the characterization of investments made after separation and before a judgment is entered.
Valuing a small percentage of many portfolio companies is prohibitively expensive and not practical. The parties will generally continue to own the community share in the investments until there is a sale or other exit event. This requires the venture firm partner to hold the spouse’s interest in constructive trust until the distribution which subjects the partner to continuing fiduciary duties.
Issues Related To Executives In Orange County Divorces
An executive’s divorce may involve unique issues in an Orange County divorce. Executives may have qualified and non-qualified benefits that need to be valued in a divorce. On occasion, a benefit may not have significant value but yet is complex (example: underwater stock options). You want a lawyer who has previously dealt with these issues and can cost effectively address the issues.
We have represented clients and spouses of clients employed by most of the large employers in Orange County including:
- Ingram Micro, O’Neil, Quicksilver, Oakley, Core Logic, Fletcher Jones, Ivantis, Western Digital, Edwards Life Science, UCI, Boeing, Anaheim Ducks, Los Angeles Angels, Kaiser Permanente, Pimco, UBS, SmithBarney, JP Morgan, LPL, Merill Lynch, Morgan Stanley, Five Point, Blizzard Entertainment, The Walt Disney Company, Snapchat, BDO, Deloitte, Ey, Irvine Unified School District, LAPD, Optum, Southwire, SAP America, Microsoft, Farmers Insurance, SoCal Edison, Biola University, Grant Thorton, Wells Fargo, Toshiba, Allergan, Irvine Company, Minolta and Phillips
Corporations compensate their executives in many different ways which complicates the analysis of a compensation package which may impact the amount of support paid and the community property balance sheet. The follow are examples of executive compensation:
- Stock Options
- Restricted Stock Units
- Profit units
- Phantom stock
- Performance units
- Retention bonuses
- Employment contracts
- Key man life insurance
- Preferred rate/loans
- Non-qualified deferred compensation
- Deferred savings plans
- Retirement plans
- 401k matching
- Elective deferral programs
- Deferred compensation programs
To the extent that any of these benefits are acquired and earned during the marriage they are community property that will be part of the equal division of the assets. When an asset is acquired may be the subject of significant dispute. If the benefit is partially owned or partially vested at the time of separation, the ownership of the benefit will be allocated between community property and the separate property of the employed spouse.
If a spouse’s employer is being sold or has been sold, there are other issues that need to be addressed. Examples include covenants not to compete, change of control bonus, success bonus, and employment contracts post sale.
Skilled Guidance for Business Owners and Professionals
For over 46 years, Minyard Morris has provided business owners and upper-level professionals high-caliber divorce representation. To discuss your options with a knowledgeable divorce attorney, call our Newport Beach office 949-724-1111 or send us an email inquiry to schedule a consultation.