Herlihy Family Law
Alison Herlihy is a dedicated family law attorney with roots in Mobile, Alabama.
Herlihy Family Law
EP #8: Business Valuations in Divorce: What You Need to Know with Guest Mike Reibling
Discover the intricate world of business valuations in divorce with certified valuation analyst Mike Reibling as he unveils the essential processes that determine how business assets are assessed and divided when marriages end.
Most divorcing couples with business interests face a critical question: what's this company actually worth? This episode dives deep into this complex financial landscape, exploring how courts determine business value, distinguish between personal and enterprise goodwill, and identify attempts to manipulate company finances during divorce proceedings.
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Welcome to the Herlihy Family Law Podcast, your trusted source for expert insights on navigating family law matters with clarity and care. Whether you're tackling tough decisions or seeking guidance for your family's future, we're here to help.
Alison Herlihy:Let's get started for your family's future. We're here to help. Let's get started. Welcome back to the Herlihy Family Law Podcast. I'm your host, allison Herlihy, founder of Herlihy Family Law in Mobile, alabama. On today's episode, we're diving into an important and often complex topic business valuations in the context of divorce. Joining me is Mike Reibling, a certified public accountant and certified valuation analyst. Mike has extensive experience in helping individuals and attorneys determine the value of businesses and other assets in the divorce process. Whether you or your spouse own a business or you're simply curious about how business assets are assessed and divided, this conversation will give you some valuable insight. Let's get started, mike welcome. Thank you for being here.
Mike Reibling:Well, I appreciate the invitation and look forward to this. To answer the first question what exactly is a business valuation and why is it important? Well, a business valuation is often going to be the primary asset in the marital estate. It may have ownership partially by either spouse, or it may be owned 100% by one spouse, but nevertheless, the fact is that there needs to be a business valuation to determine what the value is for purposes of the marital estate because, at the end of the day, it's up to the court to make. It is extremely important to have a business valuation done.
Alison Herlihy:Yeah, that's true. I mean, it's really hard for the court to equitably divide all the assets when they don't know what one of the major assets is even worth right.
Mike Reibling:That's very correct.
Alison Herlihy:What credentials or experience should someone look for in a valuation expert?
Mike Reibling:For business valuations. We have primarily two credentials issued by organizations that focus entirely on business valuations, and one of them is the CVA, a credential that I have and it's for certified valuation analysts. It's issued by the organization National Association of CVA's. The other credential is called ABV. It's accredited in business valuations, it's accredited in business valuations and it's issued by the American Institute of CPAs. I also am a certified public accountant, so pretty much cover all the bases.
Alison Herlihy:Yeah, for sure. So how is a valuation analyst different than a regular CPA?
Mike Reibling:Well, a regular CPA is going to have their focus on preparing tax returns. They're also going to be involved in providing some consulting to clients about taxes. They're also going to be preparing financial statements for the business if the business requires it, financial statements for the business if the business requires it. And they'll also periodically be doing audits of businesses that might be required because of the nature of the business itself, whether it's related or relies on governmental funding then more than likely there's going to be a required audit. So that's what CPAs do. There's going to be a required audit. So that's what CPAs do. They don't necessarily have the training to do business valuations, but they do a great job in everything else.
Alison Herlihy:What are some of the common methods you use to value a business?
Mike Reibling:The method that for most of the businesses that I deal with, these aren't public companies, they're not Fortune 500 companies, they're companies that, particularly in the mobile area, most attorneys are dealing with in a divorce process. But I mainly focus on determining what the cash flow is out of the business, and this all falls under a title called income approach, and I'll talk why that differs from some other approaches. But the income approach has two different methods. One is discounted future cash flows, where we basically project out what's going to happen into the future and establish a value from that point. Obviously we're concerned about what happened historically, and if everything is going to pretty much stay the same, expected to not change a whole lot other than inflation, then we use what we call capitalization of earnings approach. So those are the two income methods Don't really rely on market comparables, like you see in the real estate market, primarily because it's very difficult for smaller businesses less than Fortune 500 companies to have comparable companies out there, and so for that reason we primarily deal with the cash flow of the business At the end of the day, that hypothetical buyer or the judge in the courtroom, they're more concerned with how much cash that either party is going to have at the end of the day.
Mike Reibling:That's why projecting cash flows is so important.
Alison Herlihy:Are certain industries harder to value than others?
Mike Reibling:You know I thought about that question, but not really. If you're valuing a business based on what the cash flows are of the business, you know it really doesn't make any difference what industry it might be in. You can have situations and I will do this periodically you can have situations and I will do this periodically where the company on its balance sheet may be so capital intensive and that means they have a lot of money out there that they've spent on the equipment they use to produce cash flow and therefore, if the cash flow isn't up to the level of the value of what we call the net assets, then we'll consider applying a weighting factor. Like we may value the cash flow because it's the king, but sometimes we may value that at maybe 80% and the net assets at 20%. So other than that, most of the time it doesn't make any difference what the industry is.
Alison Herlihy:So I'm imagining you know something, maybe like say, you have a construction business where somebody's got tons of like bulldozers and equipment. I mean that's going to look different than if someone has like a solo law practice where you don't really have many physical assets, right?
Alison Herlihy:That's correct, but even with all the bulldozers and everything, they're out there producing X number of dollars of cash flow, and so cash flow is still important, but, like I said, we'll take a look at what the fair market value is of all that equipment. Yeah Well, in your experience, how frequently do small business valuations come into play during divorce proceedings?
Mike Reibling:Well, that's a good question, because most of the time when I'm involved in it, it is a divorce and there is a business. It's probably almost 100% of your case. A divorce and there is a business it's probably almost 100% of your case. Well, that's correct. But you can have other things going on within a divorce that is not necessarily a business valuation.
Mike Reibling:It might be something like I've had, and I think in the last four months I've had two cases where what the owners are not the owner spouse, but one of the spouses has a commitment to pay alimony of a certain dollar amount and they have now retired and they're trying to argue that they can no longer afford to pay that alimony. A lot of times it might be professional people doctors who may have been making $350,000 a year. Now all of a sudden they're not making that and they have some hefty alimony payments and legitimately they're appealing to the court to have their alimony reduced or removed. And so I went through the process of projecting out until their longevity date and seeing how everything's going to work out at the end. In those type of cases, what you're trying to do you're trying to equalize what the two different parties might have at a certain date and time, whether it's mortality age or when it is.
Alison Herlihy:Oh, that's really interesting Because I mean, I think you know you typically expect that somebody who's you know 75 is not going to be working at the same level that they were when they were 55 or 35, right?
Mike Reibling:Sure, yeah, sure.
Alison Herlihy:What are some of the most important documents or financial records that you need to conduct an accurate evaluation, so like if a client and their lawyer are working together to gather documents and discovery. What are the key documents they need to get to you?
Mike Reibling:The first thing I request and it doesn't make any difference whether it's divorce or otherwise is the last five years' tax returns and or financial statements. And I'll also request if they use QuickBooks. I'll request a backup of the QuickBooks because in preparing a business valuation I do a lot of analytical work and it's far easier to have that QuickBooks backup so that I can go in and select data, print it into an Excel spreadsheet and be able to analyze the heck out of it. And so those are the items I primarily request, attorney who has engaged me, and just to get feedback and learn more about the business as I continue to develop the business value.
Alison Herlihy:So does the QuickBooks backup. Does that enable you to kind of pick and choose what information you want to see and how you want it presented, versus like having someone else just give you their own profit and loss statement?
Mike Reibling:That's correct. I can go in, look at all the detail and you know pretty much get a lot more out of the financial data than you would just receiving a profit and loss statement or balance sheet.
Alison Herlihy:Yeah, so it allows you to run whatever reports you need to run.
Mike Reibling:That's correct.
Alison Herlihy:Okay, interesting. So how do you determine whether a business is a marital asset or a separate asset? You kind of touched on that a little bit in the beginning with retirement, for instance, asset.
Mike Reibling:You kind of touched on that a little bit in the beginning, with retirement, for instance, Whether it's a metal asset or not, again, it's ultimately. Let me back up a minute In the state of Alabama. Alabama is one of those few states who has not set a precedent as to whether personal goodwill is included in the marital estate. So when we talk about that, that really becomes a decision, a decision of the judge and the facts in the case.
Mike Reibling:Having said that, there are certain areas that are going to be premarital versus post-marriage. I said that, right, yeah, several times where you have a person who's been working at somewhere like Chevron and they have an excellent 401k profit-sharing plan, but they were an employee and in that plan five, six, eight years before they married the person they're now planning to divorce. The person they're now planning to divorce. Well, given that the next portion that they had when they got married can be a non-marital asset, not only the balance that they had at that point but also the earnings on that portion of their 401k can be determined to be a non-mortal asset.
Alison Herlihy:Yeah, so that's something that you can do for people as well. Right, right, figure out what part needs to be segregated out.
Mike Reibling:Right.
Alison Herlihy:Yeah.
Mike Reibling:And it's similar with a pension plan.
Mike Reibling:You can have a defined benefit plan even though we don't see those a whole lot anymore. A defined benefit plan even though we don't see those a whole lot anymore, the fact is that there are still a number of those out there, particularly for people who are older, and those things have they can have premarital value. Again, similar circumstance If the person had that pension plan several years before they got married, then you're going to have earnings related to it before and earnings related to it after they got married. And also with a defined pension plan, you also I do present value determination of, because a pension plan is going to have future payments, right, and so they may or may not have cost of living increases, but in one way or the other it's going to be a stream of future payments and I will go in and develop what the present value is of those payments and that becomes part of the marital asset and I think that would become especially important if, for instance, you have somebody of those payments and that becomes part of the marital asset.
Alison Herlihy:And I think that would become especially important if, for instance, you have somebody that is still working right now while they're getting divorced and they're not going to draw the pension for 10 more years.
Mike Reibling:That's correct.
Alison Herlihy:So the former spouse shouldn't get the benefit of that person's future work after the divorce. So that's why we have to figure out what's it actually worth today, right?
Mike Reibling:That's exactly right.
Alison Herlihy:Yeah, what happens if one party is not forthcoming with the business information that's needed for the valuation?
Mike Reibling:That's never happened.
Alison Herlihy:No, everybody just turns everything over and totally cooperates, right.
Mike Reibling:Oh yeah, it's all collaborative. Most of the time it can be difficult to get information out of the party, but a lot of times they're pretty forthcoming, particularly the owner-spouse the majority owner-spouse of the business will turn over the information and also it depends on the attorney. Some attorneys are a little more reluctant to do that than other attorneys, but there are different ways and methods to go in and find out if there are assets that might be hidden, and I differentiate that from unknown. Sometimes there may be deliberate hidden assets cases before over the years where you know it's pretty evident that one of the spouses determined five years before they filed for divorce that they need to plan for the divorce and because of that you'll find different shell corporations and what have you that you've got to go through and trace what's actually happened.
Alison Herlihy:I can think of a case I had years ago where, like every LLC you would find would be owned by like three other LLCs, and then you have to find out who owns those LLC. I mean it was like tough to unravel.
Mike Reibling:Well, yeah, the cases would get to big publicity.
Mike Reibling:Of course are the national order. Maybe billions of dollars have been, have been embezzled, but with small businesses you can. You can have the same situation, I mean just on a smaller scale. But if the attorney generally has the ability to try to find other assets that might be hidden by virtue of the subpoena, they can go in and subpoena any records related to the person's Social Security number or anything that might be associated with the bank that they use. If they use Regents Bank, for instance, a subpoena can ask for any records associated with this particular individual, particularly either their Social Security number or the business tax identification number or the business tax identification number. So there are ways and sometimes and I've seen it where it's kind of frustrating the attorney will request all that, they'll do the subpoena and they get no response and what eventually happens. There are other, stronger methods, and Allison can use the right terminology to help me out with that. But they can go in and basically possibly bring down the hammer from the court to make them turn over documents.
Alison Herlihy:Yes, sometimes we have situations where the third party that you're trying to subpoena doesn't respond. So the third party might be a bank or other financial institution. Or sometimes we try to subpoena someone's CPA to get their records and if they refuse to respond, we can file a motion to show cause and have them served with that, even though they're not a party, and the court will set that for a hearing and order them to appear and say you know you have to turn this stuff over, why didn't you do it? So they're definitely all late, but sometimes you have to really be aggressive and persevere with getting the information that you need, because people don't always make it easy.
Mike Reibling:From my perspective, sometimes that can get overbearing. In a recent case, the local larger CPA firm who was representing both parties doing their individual tax returns, but also the business which was owned by one party 100 percent. They answered the subpoena with 176 files and you know, from my perspective I've got to go through and look at all 176 files and try to determine what's really applicable to this case and what isn't.
Alison Herlihy:Right, yeah, well, you touched a little bit earlier on the topic of goodwill and that Alabama doesn't actually have a set precedent about that. So, assuming that whether to include goodwill or not is basically in the judge's discretion in any particular case, do you have an opinion Like do you come down on one side, or the other about when it's appropriate to include that and when it's not other about when it's appropriate to include that and when it's not.
Mike Reibling:I've again had several cases where that's become an issue and to give you some examples, you have a restaurant, you have a chef who's famous locally and everybody goes to that restaurant because that chef's there. And a lot of times these aren't big restaurants. But the question becomes if that chef left, what's going to happen to their income, to their customer base, if he's so important to the business? And you get similar situations with dental practice where that dentist that everybody's been going to for years, they love that person, and all of a sudden that person was in the investment business and excellent, excellent job at what he, what he was doing. But the question becomes you know he was the lone wolf, he did everything. What? What happens? If he walks outside, it's run over by an 18 wheeler and what, what is? What would be the value of the business?
Alison Herlihy:and those are those are the questions we have to ask?
Mike Reibling:there is some. I saw an expert on the other side use it not too long ago. It's a utility called MUM M-U-M and basically it has a list of questions to determine whether there's personal goodwill or whether it's what we call enterprise goodwill. Enterprise goodwill is the value of the total business. Personal goodwill becomes the value that might be attributed to that owner who does everything, but what the mom does is answer certain questions and a lot of times it's going to still come up and tell you that. You know, this is all personal goodwill. It's not enterprise goodwill and basically it's up to the court to make the decision as to whether it's included in a marital estate or not.
Alison Herlihy:So I guess enterprise goodwill would be like I only shop at Publix grocery store just because it's the best.
Mike Reibling:That's correct, so it's not the person who works there.
Alison Herlihy:It's like, whereas if you always have gone to say you know Bob the mechanic and you know he really knows how to work on your car and he charges fair prices, well, it doesn't really matter where Bob is, you might follow Bob wherever he goes, right.
Mike Reibling:Yeah, that's correct.
Alison Herlihy:Yeah, okay. So what are some of the most common misconceptions people might have about the value of their business?
Mike Reibling:One of the major misconceptions is that their business is their retirement plan and that can come up and provide a reality check.
Mike Reibling:Because when people have that attitude about their business, they think that, okay, when we retire we'll be able to sell that business and it will have X number of dollars of value and we'll be able to live comfortably in retirement.
Mike Reibling:A lot of times the value doesn't match what their expectation is, and so over time, they haven't taken advantage of other retirement vehicles in order to build up that retirement nest egg other than social security, and so, for for that reason, the um, we, we, we have to, uh, we'd like to get in sooner with those type of businesses and help them either grow their business or do whatever.
Mike Reibling:What I see with small businesses particularly where it's and I call them mom and pops, but they may generate $5 million in revenue is that they work their tail ends off in the business. Revenue is that they work their tail ends off in the business and between the two of them they take a combined salary of $40,000 a year. When we do a business valuation, we come in and we look at the business from the perspective of what do you have to pay people to do the same thing they did and we call it reasonable compensation. And rather than being $40,000, it may be $140,000. So all of a sudden, when you put that extra expense in the business valuation, it obviously decreases the business value.
Alison Herlihy:Yeah, so if you have one of those kind of yeah, like you said a mom and pop where they, you know, the wife's doing the books and scheduling the appointments and the man's going out and doing estimates and repairs or whatever kind of stuff they're doing, If you had to actually hire two people to do that work, you'd have to pay them a lot more money, right?
Mike Reibling:Exactly.
Alison Herlihy:What are some red flags you can say that would suggest that a business owner might be trying to undervalue their company?
Mike Reibling:A couple of red flags. Number one and we talked about these possible other related companies out there, out there Whenever I see management fees as an expense for the business, I want to pretty much track that through, because that's an opportunity to basically deplete the value of the business by paying management fee to another entity that's probably owned by the same business owner, and so you've got to track that through. I had a case this probably five years ago where the guy came in divorce situation and he came in. He had a lucrative business but he set up this other company and he started paying management fees to it of I don't know four hundred thousand dollars a year, which had a very detrimental effect on the business value. Except for the fact that I ignored it.
Mike Reibling:It's facts and circumstances. Whenever you see something like that, another thing that we'd look for is if the property is owned outside of the business, like the building they're in, and they're paying rent for that property. Sometimes the rent can be exorbitant because it's separately owned in that other business. So we do take a look at that. We'll go in and compare the per square foot rent that's being paid by the business versus what might be the trend within that particular area.
Alison Herlihy:Yeah, what the reasonable market value is.
Mike Reibling:Exactly so we'll.
Alison Herlihy:Sorry to interrupt. I would think another thing you'd want to kind of look out for would be if you see a lot of loans flowing between the owner and the business and it's unclear kind of what those are for.
Mike Reibling:Yeah, I agree, and we do look at that.
Mike Reibling:But we also look at the bank accounts, particularly if there are a lot of transfers out of the business bank account.
Mike Reibling:It tells us several things that there are amounts coming out of the business that are going somewhere else and it tells us where they're going to.
Mike Reibling:So in some cases you might have investments out there where the owner is taking a lot of money out of the business and putting it into this outside investment, like Charles Schwab or what have you, and it's growing out there and it should be a marital asset. But it may be known or unknown until we go through that process and find that there's money going to that particular fund. So there are several ways of calling red flags or whatever that we will go in and analyze it and try to determine where that money is going and how applicable it is to the business is to the business. I also have situations where the spouse on the other side is pretty diligent about trying to find stuff that the other spouse may have spent through the business, even within their credit card details, and they will submit to their attorney a lot of those different items for basically further investigation as to whether they're really business expenses or not?
Alison Herlihy:Yeah, and that can become really important when you're looking at what child support and alimony is supposed to be like. What child support and alimony is supposed to be Like if someone says oh well, I only pay myself a salary of, you know, $40,000 a year, but then they're paying all these personal expenses out of the business.
Mike Reibling:that's really their income too. Yeah, Like I said, the other spouse is pretty diligent. Sometimes you'll find that apartment that's being paid for and there's a question as to why that's happening.
Alison Herlihy:Those are good questions. So what are some of the most challenging aspects doing this kind of work in a divorce context?
Mike Reibling:Some of the most challenging are related to getting course documents, getting QuickBooks back up. Some attorneys representing the other party are reluctant to give up QuickBooks data. They'd rather just give you the one printed reports and not give you anything behind the background. And that gets very frustrating because it makes my job more difficult. It makes the attorney's job more difficult, so that's a challenge. Also, getting involved late and I think we addressed it in another question also but getting involved in the case late in the case, sometimes the process of getting a business valuation is secondary to everything else that's going on like custody battles and other issues, child support, so there's a lot of other things that are going on and sometimes the attorney just procrastinates or whatever and doesn't realize that they need to get somebody like me involved early.
Alison Herlihy:Yeah, that's a great tip. Like to think to get a business evaluator involved earlier in the process.
Mike Reibling:We run into situations too where you know generally I do not, I don't want to know the background story, but sometimes you'll get, particularly if you're meeting with one party or the other, one of the spouses they will sometimes unload on you. Yeah, tell you all the drama.
Alison Herlihy:It's a very emotional process.
Mike Reibling:They'll tell you all the drama, trauma in the background. They'll tell you all the drama, trauma in the background. I've, I've had, I've had people, male and female, crying and, because it's such such an emotional situation and it is, you know, I've, I've sat in the in the courtroom and mobile in the hallway outside of divorce court and the chairs are filled with people and, you know, one party generally, along with the kids, are on one side of the hallway there, the other is on the other and it's really emotional to see the kids going back and forth between the two parties, realizing what the situation is. But, like I said, I try not to get involved in the drama, trauma and the background stories.
Alison Herlihy:Yeah well, processing the emotions really isn't your purview, right? It's the numbers and the facts, right?
Mike Reibling:It's the numbers and the facts. You know, I've said before that we should be. We have to have some tendency toward being social psychologists, just in dealing with some of the clients.
Alison Herlihy:What advice would you give to a business owner who's going through a divorce?
Mike Reibling:Be honest, provide anything and everything that the parties request. The court requests, the attorneys request, because the worst thing that can happen is getting into court and there'll be a trial, particularly regarding the value of the business and doing that cross-examination of that owner. All of a sudden, those smoking guns come out that basically are saying that he's provided inaccuracies to the court and judges don't really like that and therefore you have this situation. That may or may not affect what the ultimate decisions are in the case, but the fact of the matter is you want to be honest and you want to provide everything so you never have to run into that situation.
Alison Herlihy:Yeah, I tell clients all the time that most of the time, getting caught in a lie is going to be worse for your case than whatever it is you're lying about.
Mike Reibling:Yeah right.
Alison Herlihy:Yeah, honesty is always the best policy, for sure. Well, Mike, thank you so much for joining us today and sharing your expertise and your insights on business valuations. I know this is a topic that comes up often in family law cases and your perspective is really helpful. Where can people find you if they want to consult with you about a business valuation?
Mike Reibling:consult with you about a business valuation. Well, I can provide an email. I've actually had an office in home since 2004. I was a partner with Lawrence Lawrence, a big CPA firm here in town, for about 12 years, but everything I was doing I was doing on my own. So I decided to bring it home and for years I had two administrative assistants. Both of them were Yorkies and they were very attentive to my needs and made sure I got up periodically.
Alison Herlihy:Well, that's good. Well, I know where to find you if people need to find you. So okay. Thanks again for everybody that's listening. If you enjoyed this episode, please leave us a review or share it with someone who might find it helpful, and we'll be back soon with more insights from the world of family law. Thanks again, mike.
Mike Reibling:All right. Thank you, Allison.
Alison Herlihy:Yeah law.
Intro/Close:Thanks again, Mike All righty. Thank you, Allison. Yeah, Thank you for tuning in to the Hurley family law podcast. Remember you don't have to face family law challenges alone. Visit Hurley family law. com or call 251-432-7909 to learn more.