Getting the right value for a business involved in a Pennsylvania divorce is crucial to a fair and equitable result. The courts generally do not require business owners to sell their interests, and judges do not force divorcing spouses to become unwilling business partners, unless the spouses agree. After identifying property that qualifies as marital in an equitable distribution proceeding, the second step is determining its value. In the Pennsylvania courts, the most frequently used standard is fair market value.
Fair market value sounds like a simple concept, but it is challenging. Many owners, lawyers and even judges do not fully grasp the principle until they face a divorce proceeding in which they must apply it. The partners of Pollock Begg have concentrated for years on how businesses are valued in Pennsylvania divorce proceedings. We have learned to work with valuation experts, owners, spouses and the court to determine the fair market value of businesses subject to equitable distribution proceedings.
What is fair market value in a Pennsylvania divorce?
Fair market value is legally defined as “the price at which the property would change hands between a willing buyer and a willing seller when the former is not under any compulsion to buy and the latter is not under any compulsion to sell, both parties having reasonable knowledge of relevant facts.” Understanding fair market value requires a shift in perspective: viewing the business or property from the position of a potential buyer. Fair market value does not depend upon an actual transaction or a particular buyer or seller. Pennsylvania law does not specify fair market value for use in divorce litigation; however, this standard has prevailed historically over other standards, such as fair value.
The fair market value standard incorporates certain assumptions, including the assumptions the hypothetical purchaser is not motivated by any synergistic or strategic influences, the business will continue as a going concern and not be liquidated, the hypothetical sale will be conducted in cash or equivalents and the parties are willing and able to consummate the transaction. These conditions are assumed because they allow a meaningful comparison between businesses which are similarly situated.
How is fair market value different from other standards?
Fair market value is derived from a hypothetical purchaser who might buy the business without any special motivation. Some potential buyers, such as competitors, might pay a premium for a business in order to eliminate the competition or create economies of scale by consolidating operations. Those considerations must be eliminated. Fair market value is often greater than a company’s book value, which is the sum of its assets and liabilities on the balance sheet, and if the company is profitable, fair market value is greater than liquidation value because a buyer would probably pay for the right to receive the future profits a company can generate in the future.
A similar but different standard, called fair value, is used in some jurisdictions and is approximately equal to fair market value without certain discounts. Fair value has not been adopted in Pennsylvania, however, because it is not an objective measure of a company’s value. Fair value disregards the valuation discounts that must be applied when a company’s stock is not publicly traded and the discounts applicable to a minority interest which does not include the prerogatives of control. The fair value standard makes assumptions which are often inconsistent with the business interest being valued.
Valuation is a critical element of equitable distribution proceedings, which is why Pollock Begg lawyers have devoted themselves to learning and advocating the principles of business valuation. Before entering a courtroom where the fair market value of a business will be decided call to make an appointment with one of our attorneys.