Impacts of Buy/Sell Agreements on Business Valuation for Property Division in Divorce Cases

Not too long ago, I wrote about the ins and outs of valuing a community property business in a divorce case, particularly regarding aspects of a business owner’s “good will” – or the expectation that the public will continue to patronize the business after the divorce because of the reputation the community business had garnered during the marriage. As I explained in that post, the calculation of “good will” can be complicated, time consuming, and ultimately very expensive. And that calculation may not be required in every business – which brings us to the topic du jour.

When business owners set up the corporate or partnership entities at the outset, one option those owners have is to include a “buy/sell” agreement. The purpose of the buy/sell agreement is to streamline the process of dissolving a business owner’s interest in the business when more than one person owns the business or the business is comprised of more than one partner. The agreement will lay out for the entity the manner in which the ownership interests are to be valued if a partner or owner leaves (i.e. some formula based upon percentage of income generated by the person, a set share price with a standard of calculation, a multiple of the accounts receivable, etc., a Fair Market valuation by a CPA, or just a flat buy out amount).

Further, the agreement should also state the “triggering events” leading to the enforcement of the buy/sell provisions. In most cases, these will include death, retirement, voluntary termination of the owner’s interest in the business, divorce, an owner’s bankruptcy, disability, and any other event that the business owner’s believe would justify a buyout. The business’ goal is to avoid having to incur the expense of hiring an accountant (which can be expensive) to value an individual owner or partner interest in the business when that person leaves the business or another triggering event has occurred.

In most cases, if the business owners or partners are married, the spouse will have to sign a “spousal consent” to whatever form of valuation the buy/sell agreement establishes. This is done as a prophylactic measure so that the business does not need to defend itself against a lawsuit initiated by the spouse if that spouse believes that the ultimate determination of value is not fair.

And this brings us to the impact that a buy/sell agreement can have on a business valuation for property division purposes in a divorce.

Ultimately, if the valuation method in the buy/sell is deemed to be a reasonable estimation of an owner’s interest in the business, the buy/sell agreement many in fact be the only determining factor in valuing the non-owning spouse’s share of the business. The goal as always in a divorce is to ensure that each spouse receives his and her equal share of the reasonable value of the community estate. If the buy/sell agreement can establish that value, the spouses can avoid the expense involved with a full forensic valuation of the business, including its good will.

But that is not true in every case.

Sometimes the business owners will sign off on a buy/sell agreement that is not intended to establish a reasonable value of any of the owners’ interests in the business – the buy/sell will be drafted as a “hammer” in order to minimize the value a departing owner will realize when the buy/sell is triggered so that the owners are encouraged to stay in the business. That kind of buy/sell does not indicate what a divorcing non-owner spouse’s interest in the business is, and in those cases, a forensic valuation will likely still need to be done.

Overall, buy/sells can make the valuation process much easier and less expensive. But when the buy/sell does not tell the true story of value, particularly when the business owner spouse takes the position that a buy/sell is always determinative, the issue can become more complicated and more expensive.

California courts approach buy/sell agreements on a case by case basis, so the general wisdom to clients is that the fairer a buy/sell is to the ownership or partnership, the more likely it is that the court will support its valuation methodology.

Neil M. E. Forester is a shareholder and a California Certified Family Law Specialist with Forester Purcell Family Law (www.foresterpurcell.com). He regularly represents business owners, professionals, and other high income and high net worth individuals (or their spouses) in divorce and related actions. He also writes and speaks regularly on divorce and family law issues. Neil can be reached at neil@foresterpurcell.com or 916 293 4000. This information is general in nature and should not be construed as legal advice.

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