There is probably no more byzantine and complex process in an Illinois divorce than valuing and dividing a business. The business operating spouse will always want to keep the business while claiming the business is worthless. The spouse that doesn’t operate the business will want a grandiose share of the business’s value…without really knowing what that value is. A business’s value will surely go to trial or be negotiated fiercely.
The business owner and his or spouse, must know how an Illinois court determines the value and division of a business. More importantly, the litigants’ divorce lawyers must understand completely how a business is valued by experts who disagree and how to apply those valuations to the body of Illinois that governs the valuation and division of businesses in an Illinois divorce.
Is a Business Marital or Non-Marital In An Illinois Divorce?
“The court shall make specific factual findings as to its classification of assets as marital or non-marital property, values, and other factual findings supporting its property award.” 750 ILCS 5/503
For business interests non-marital property is, typically, property acquired before the marriage or via an inheritance/gift.
[T]he following…is known as “non-marital property:”
“property acquired before the marriage” 750 ILCS 5/503(a)(3)
“property acquired by gift, legacy or descent or property acquired in exchange for such property” 750 ILCS 5/503(a)(1)
The non-marital property MUST stay with the party in whose name that non-marital property remains.
“[T]he court shall assign each spouse’s non-marital property to that spouse.” 750 ILCS 5/503(d)
“Real property and business interests acquired after marriage are presumed to be marital property unless they were purchased with nonmarital funds.” IN RE MARRIAGE OF SCHMITT, 909 NE 2d 221 – Ill: Appellate Court, 2nd Dist. 2009
“The business interest of a spouse acquired subsequent to marriage constitutes `marital property’ subject to equitable distribution upon dissolution.” In re Marriage of Schneider, 343 Ill.App.3d 628, 634, 278 Ill.Dec. 485, 798 N.E.2d 1242 (2003)
Businesses that have portions thereof that were acquired before the marriage, ex: a building that was bought after the marriage, will have those potions deemed to be non-marital. The increase in value of those pre-marital properties will also be deemed non-marital.
Business properties “owned before the marriage are…nonmarital property. They are no doubt worth more now than they were then. However, the increase in value of nonmarital property is nonmarital property.” In re Marriage of Kennedy, 418 NE 2d 947 – Ill: Appellate Court, 1st Dist. 1981
Business interests acquired AFTER the marriage but were purchased by assets which were acquired BEFORE the marriage may retain their non-marital character.
Non-marital property is “property acquired in exchange for property acquired before the marriage” 750 ILCS 5/503(a)(2)
The counter-argument is that any contribution from non-marital business into what could be a marital business property is transmutation.
“Transmutation is based on the presumption that the owner of the nonmarital property intended to make a gift of it to the marital estate.” In re Marriage of Vondra, 2016 IL App (1st) 150793
Furthermore, any personal effort from a spouse post-marriage towards a non-marital business can be considered by an Illinois court. “When a spouse contributes personal effort to non-marital property, it shall be deemed a contribution from the marital estate, which shall receive reimbursement for the efforts if the efforts are significant and result in substantial appreciation to the non-marital property” 750 ILCS 5/503(c)(2)(B)
If the spouse was on payroll, however, that contribution to the non-marital business will be considered already paid for.
No reimbursement to a spouse who worked on a non-marital business shall be made “if the marital estate reasonably has been compensated for his or her efforts, it shall not be deemed a contribution to the marital estate and there shall be no reimbursement to the marital estate.” 750 ILCS 5/503(c)(2)(B)
The less clear it is whether a business is marital or non-marital, the more likely the business property will be deemed marital.
“Any doubt as to the nature of the property must be resolved in favor of the finding that it is marital” In re Marriage of Steel, 2011 IL App (2d) 080974
How Does A Business Get Divided In An Illinois Divorce?
Parties to a divorce where one or both spouses own a business can divide the business, the businesses value and/or the business’s future income however the parties agree.
“To promote amicable settlement of disputes between parties to a marriage attendant upon the dissolution of their marriage, the parties may enter into an agreement containing provisions for disposition of any property owned by either of them, maintenance of either of them, support, parental responsibility allocation of their children, and support of their children” 750 ILCS 5/502(a)
“The law favors the amicable settlement of property rights in marital dissolution cases, and all presumptions are in favor of the validity of the agreement.” In re Marriage of Prill, 2021 IL App (1st) 200516 (citations omitted)
Agreement as to value and division of a business is often only possible when both parties have equivalent knowledge of the business’s operations and future earnings. Equal knowledge of the subject business is usually only possible if both parties work in the business. Courts will rarely, if ever award portions of a business to both spouses…where the now-ex-spouses must work together.
“[W]hen the property at issue is a small business and the parties have shown that they cannot work together, it is better to award the business solely to one party or the other.” In re Marriage of Thomas, 608 NE 2d 585 – Ill: Appellate Court, 3rd Dist. 1993
Illinois divorce courts encourage full apportionment of a business in a divorce for the sake of “finality [and] to avoid continued need for court intervention…[The] division of the property…avoid[s] ongoing association between the parties [and] are goals to be consider[ed] in apportioning such marital assets.” In re Marriage of Moll, 597 NE 2d 1230 – Ill: Appellate Court, 2nd Dist. 1992
“Distribution of a business interest can present difficulties, and the court should be mindful that divorcing parties might be unable to work together in a continued business association.” In re Marriage of Schlichting, 19 NE 3d 1055 – Ill: Appellate Court, 2nd Dist. 2014
If both parties do not work in the business, there is usually a massive gap in the understanding of the business’s value and income between the spouse that operates the business and the spouse that does not operate the business. Therefore, division of a business and its value is not resolved until that knowledge gap is closed…or a divorce court rules upon the value and division of the business.
Once deemed marital in nature, the business (or portion thereof), an Illinois divorce court “shall divide the marital property without regard to marital misconduct in just proportions” 750 ILCS 5/503(d)
In Illinois, this division of marital assets is not a pure 50/50 split of each asset.
“The [Illinois Marriage and Dissolution of Marriage] Act does not require an equal division of marital property, but an equitable division” In re Marriage of Jones, 543 NE 2d 119 – Ill: Appellate Court, 1st Dist. 1989
Unless the parties work together in the business and agree to continue working together, the business will not be divided between the parties.
The spouse that knows how to continue to earn income from the business will inevitably be awarded the business. The business operator spouse will be awarded the business because they are the only one who can take advantage of “the reasonable opportunity of [a] spouse for future acquisition of capital assets and income.” 750 ILCS 5/503(d)(11)
The court will also consider “each party’s contribution to the acquisition, preservation, or increase or decrease in value of the marital or non-marital property, including…the contribution of a spouse as a homemaker or to the family unit.” 750 ILCS 5/503(d)(1)
The spouse that did not operate the business will inevitably be deemed to have contributed to the family to an extent that allowed the business to flourish and, therefore, should be awarded a portion of the value of the business.
The portion of the value to be awarded is usually less of an issue than the value of the business itself.
How Do You Value A Business In An Illinois Divorce?
When discussing a business in an Illinois divorce, we are virtually always discussing a closely held corporations or partnerships.
A closely held corporation is “a corporation whose stock is not freely traded and is held by only a few shareholders” Black’s Law Dictionary (11th ed. 2019)
Closely held businesses are distinguishable from businesses which are publicly listed on a stock exchange. The value of a publicly listed company can be determined at any given moment based on the traded price of the stock. Closely held companies do not work that way…so we have to make an educated guess as to what the
“In a close corporation the corporation’s shares are not listed on a stock exchange or actively dealt in by brokers and, therefore, there is no established market for the corporation’s stock.” In re Marriage of Olsher, 78 Ill. App. 3d 627, 635 (Ill. App. Ct. 1979)
Businesses cannot typically be divided in two. The business operator almost always keeps the business after an Illinois divorce. If the business has been deemed to be marital, a portion of the business’s marital value will be awarded to the spouse that will not operate the business in the future.
Furthermore, closely held businesses may have more than one shareholder. The shareholders are usually bound by an operating agreement that requires that they only sell or transfer shares to each other or third parties only if agreed.
A closely held corporation’s “operating agreement is to be enforced according to general contract principles, unless it conflicts with a statute.” In re Marriage of Schlichting, 19 NE 3d 1055 – Ill: Appellate Court, 2nd Dist. 2014
The value of the business is the fair market value.
“In determining the value of assets or property under this Section, the court shall employ a fair market value standard.” 750 ILCS 5/503(k)
Fair market value is “what the property would bring at a voluntary sale where the owner is ready, willing and able to sell but not compelled to do so and the buyer is likewise ready, willing and able to buy, but not forced to do so. This is theoretically an objective standard of valuation; the value of particular property is set by the forces of the marketplace at a given place and time.” Chrysler Corp. v. ILL. PROPERTY TAX APPEAL BD., 387 NE 2d 351 – Ill: Appellate Court, 2nd Dist. 1979 (citations omitted)
There are no voluntary sales, however, in most closely held corporations. “In a close corporation the corporation’s shares are not listed on a stock exchange or actively dealt in by brokers and, therefore, there is no established market for the corporation’s stock. The shareholders of a close corporation, however, like those of any corporation, do realize a value from stock ownership in that they have certain rights of control or future profits. Furthermore, courts have recognized an ascertainable value for shares of stock in closely held corporations.” In re Marriage of Olsher, 397 NE 2d 488 – Ill: Appellate Court, 1st Dist. 1979
In lieu of a voluntary sale, the courts must rely on expert testimony to present evidence as to what the fair market value of the business would be…if there were voluntary sales.
“To place a specific value on an item of marital property, there must be competent evidence of its value presented.” In re Marriage of Abu-Hashim, 2014 IL App (1st) 122997
“Placing a fair market value on the professional corporation is an art, not a science, and the court must rely on expert witnesses to assist it in this difficult task. There is no exact formula that can be applied, so the trial court must rely on experts who may differ significantly in both methodology and valuation. The trial court must consider the relevant evidence before it; determine the credibility of the experts, the reasonableness of their testimony, the weight given to each of them, and their expertise in the particular area of valuation; and then determine fair market value.” In re Marriage of Gunn, 233 Ill. App. 3d 165, 183 (Ill. App. Ct. 1992)
“To determine the value of a business which is marital property, the court must consider (1) fixed assets, (2) other assets, including accounts receivable, (3) the goodwill in the business, and (4) business-related liabilities.” In re Marriage of Feldman, 557 NE 2d 1004 – Ill: Appellate Court, 2nd Dist. 1990
“Precise rules for determining the value of closely held stock cannot be laid down, but rather all evidence reflecting the worth of the entity should be considered. Both the future economic outlook and the capitalization of future earnings are important tools for valuing a closely held corporation.” In re Marriage of Olson, 585 NE 2d 1082 – Ill: Appellate Court, 2nd Dist.1992 (Citations Omitted)
“A trial court can only reach its determination of value based on the evidence presented.” In re Marriage of Liszka, 77 NE 3d 1000 – Ill: Appellate Court, 3rd Dist. 2016
Experts can opine on hundreds of factors that determine or modify the value of a closely held business.
“In valuating a closely held corporation, an expert witness may take a deduction for its unmarketability, but such a deduction is not mandatory.” Blackstone v. Blackstone, 681 NE 2d 72 – Ill: Appellate Court, 1st Dist., 6th Div. 1997
“Nor has “book value” been found to be a particularly good measure for appraising the fair value of a corporation.” Blackstone v. Blackstone, 681 NE 2d 72 – Ill: Appellate Court, 1st Dist., 6th Div. 1997
It may be tempting to forgo an expert’s analysis and just lean on the value of a share of stock the last time the shares of a business were bought, sold or transferred. Transfers of stock of closely held companies, however, are not an acceptable way to determine the value of a business.
Business people can and will contract for everything, however. That means that the valuation process may be contracted for so long as the nonmember spouse has an option to contest the valuation.
“We see no reason why the trial court should have entered an order that conflicted with the terms of the operating agreement when the operating agreement specified the valuation process in the event of a divorce and allowed for the nonmember spouse to contest the valuation during divorce proceedings.” In re Marriage of Schlichting, 19 NE 3d 1055 – Ill: Appellate Court, 2nd Dist. 2014
Evidence Of Purchase or Sale Of Stock As Evidence Of Value Of A Closely Held Business
Businesses are often owned by a small group of people who have contracts amongst them that determine how they will buy and sell shares of the business between them.
If partners have made a recent sale and purchase of a portion of the business, it may be tempting to estimate the value of the business based on that sale. After all, this is how privately held firms are presumed to be valued when they raise capital.
An Illinois divorce “court is not, however, required to use such an [operating] agreement in placing a value on marital property under section 503 of the Dissolution Act” In re Marriage of Gunn, 598 NE 2d 1013 – Ill: Appellate Court, 5th Dist. 1992
A corporation and its shareholders can, effectively, contract to have the shares valued at any agreed upon rate. A divorce court does not have to honor that agreed value when determining the value of a business for the purposes of an Illinois divorce.
An Illinois divorce court can determine that “market value is sometimes above and sometimes below the actual value of the stock” In re Marriage of Gunn, 598 NE 2d 1013 – Ill: Appellate Court, 5th Dist. 1992
Furthermore, the agreement of the value of a stock is merely a reflection of that stock’s value at the moment of that agreement.
Divorce courts are not bound by past values. “[T]he value of stock fluctuates freely with the operation of the business. Therefore, a past value would not give the trial court an accurate idea of the stock’s worth.” In re Marriage of Olsher, 397 NE 2d 488 – Ill: Appellate Court, 1st Dist. 1979
There is no getting around the fact that to value a business…you need to hire an expert. Specifically, the party who will keep the business will need an expert to calculate the “goodwill” of the business which will apply as a deduction against the value of the business for the purposes of a divorce.
Using Goodwill To Argue For A Lower Value Of A Business In An Illinois Divorce
The business operating spouse will inevitably be awarded the business. Upon that determination (or a strong hint from the court) the business operating spouse will want to argue that the business has a low value.
The simplest way to explain that a business has a low value is to argue that the operating spouse’s business’s reputation is a portion of the value of the business itself. This concept is known as “goodwill”
Goodwill is “a business’s reputation, patronage, and other intangible assets that are considered when appraising the business, esp. for purchase; the ability to earn income in excess of the income that would be expected from the business viewed as a mere collection of assets.” Black’s Law Dictionary (11th ed. 2019)
“[P]rofessional goodwill is [not] subject to valuation, division or distribution as marital assets” In Re The Marriage of Zells, 197 Ill. App. 3d 232 – Ill: Supreme Court 1991
If goodwill is future income then “goodwill value is then reflected in the maintenance and support awards. Any additional consideration of goodwill value is duplicative and improper.” In Re The Marriage of Zells, 197 Ill. App. 3d 232 – Ill: Supreme Court 1991
A business owner cannot be ordered to pay child support and/or maintenance and be ordered to divide any portion of their business that can be attributed to goodwill.
“[P]ersonal goodwill, if used as a factor in calculating income potential, on which the maintenance and support awards are based, cannot also be used as a divisible marital asset.” In re Marriage of Schneider, 798 NE 2d 1242 – Ill: Appellate Court, 2nd Dist. 2003
“It has been established that a fair and just disposition of marital property requires considering goodwill in valuing a professional corporation.” In re Marriage of Schneider, 798 NE 2d 1242 – Ill: Appellate Court, 2nd Dist. 2003
If there is no maintenance, then goodwill cannot be deducted from the value of the business.
“[I]f goodwill is not considered as part of a spouse’s income-generating ability relative to a maintenance award, it may be considered in the valuation of a professional practice as a divisible marital asset.” In re Marriage of Schneider, 824 NE 2d 177 – Ill: Supreme Court 2005
What Kind Of Expert Do You Need to Value A Business In An Illinois Divorce?
You cannot provide an opinion in an Illinois divorce court unless you have been deemed an expert.
“[T]he general rule is that testimony of a witness’ opinion is not admissible into evidence” People v. Brown, 558 NE 2d 309 – Ill: Appellate Court, 1st Dist. 1990
The value of a company is an opinion. Therefore, an expert is required to provide the court with a business valuation.
There is no particular threshold to the level of expertise which is required to provide an expert opinion.
“An individual becomes an expert by studying and absorbing a body of knowledge.” Darling v. Charleston Hospital, 211 NE 2d 253 – Ill: Supreme Court 1965
“A witness may thus testify as an expert if he or she has knowledge and experience beyond the average citizen that would assist the jury in evaluating the evidence. There is no particular way in which that expertise had to be acquired; it could have come through formal study, training, or research, or through practical experience, in the relevant specialized field.” People v. Loggins, 130 NE 3d 432 – Ill: Appellate Court, 1st Dist., 3rd Div. 2019 (Citations Omitted)
The proposed expert must have a level of experience that the court deems sufficient to provide an opinion on the subject matter.
The “argument that specific experience or training in valuation is necessary is without merit because valuation is merely a small part of the larger discipline of accounting…[E]xperience testifying is [not] necessary to be qualified as an expert witness. The act of testifying does not create the specialized knowledge of an expert witness, but rather the education, training or practical experience gained prior to testifying render a witness qualified to offer an expert opinion.” In re Marriage of Olson, 585 NE 2d 1082 – Ill: Appellate Court, 2nd Dist. 1992
The level of experience of the proposed expert does not need to be exact in order to provide an opinion as to a business’s value.
“[E]xperience in valuing a certain type of business is not required to qualify an expert in valuation of other types of businesses” BRYNWOOD COMPANY, v. SCHWEISBERGER, Ill: Appellate Court, 2nd Dist. 2009
Once the expert is deemed an expert, the expert’s analysis which led to the opinion may be subject to examination.
“An expert may base his or her opinion on scientific, technical or other specialized knowledge including facts and opinions contained in a learned treatise, first-hand observations, facts and opinions introduced into evidence, and facts and opinions not admitted into evidence when such facts or opinions are the types reasonably relied upon by experts in the field.” In re Marriage of Gunn, 598 NE 2d 1013 – Ill: Appellate Court, 5th Dist. 1992
After the expert’s testimony has been deemed admissible, the court must still weigh the actual opinion. “[I]t has been recognized that an expert’s opinion is only as valid as the reasons for the opinion and the trial court must look behind the expert’s conclusion and analyze the foundations upon which the conclusion was built.” BRYNWOOD COMPANY, v. SCHWEISBERGER, Ill: Appellate Court, 2nd Dist. 2009
The expert’s testimony will be taken as a whole and no single item will be deemed dispositive.
“[I]t would be a mistake…to focus myopically on any [single] given valuation method or financial aspect of [a closely held] corporation in arguing its fair value to the marital estate.” Blackstone v. Blackstone, 681 NE 2d 72 – Ill: Appellate Court, 1st Dist., 6th Div. 1997
Typically, business valuation experts provide a variety of methods to calculate the fair market value of a closely held business. “The most successful method of appraising a business or professional practice is not for the expert to use only one approach in estimating value, but to use several different approaches, just as a real estate appraiser may estimate one value based on comparable properties, and another based on replacement cost.” (1 H. Gitlin, Gitlin on Divorce § 8.09(E)(6), at 153 (1992).)
Common methods are the 1) income approach, 2) the guideline public company method, and 3) the asset based method.
In the income approach “the value of the subject [business] …is the present value of the economic income expected to be generated by the investment…This expectation of prospective economic income is converted to a present worth – that is, the indicated value of the subject business interest…In any event, it is essential that the economic income stream that is projected to be clearly defined and that a discount rate appropriate for that definition of economic income be used in the analysis.” ASA Educational Foundation., Pratt, Shannon P.. Valuing a Business, 6th Edition: The Analysis and Appraisal of Closely Held Companies. United Kingdom: McGraw-Hill Education, 2022.p. 157
The guideline public company method “develop[s] valuation multiples based on prices at which stocks of sufficiently similar companies are trading in at public market.” Id. Page 287
The valuation multiple used in the guideline public company method “is usually a multiple computed by dividing the price of the guideline company’s stock as of the valuation date by some relevant economic variable observed or calculated from the guideline company’s financial statements.”
The asset-based approach has two methods: 1) The Capitalized Excess Earnings Method and 2) The Asset Accumulation Method.
The capitalized excess earnings method “estimate[s] an appropriate fair rate of return on the estimated net tangible assets value of the subject business, multipl[ied by] the estimated net netgible asset value [then] subtract[ing] that fair return on net tangible assets amount from the normalized level of economic earnings.” Id. p. 346
“In, the asset accumulation method, the analyst restates all the assets and liabilities of the subject company from their historical cost basis to the appropriate standard of value” Id. p. 364
Each of these methods is not conclusive but, instead, is a pattern of logic which brings us closer to the truest possible valuation when properly balanced against other valid models.
“The reasonableness of the business valuation conclusions usually depends on whether the forecasts and the assumptions used to estimate future economic income benefits are acceptable to the decision maker by whom the business valuation is being evaluated (e.g…the judge in a litigation)” Id. p. 44
Business valuation experts have to explain all of these models; where they obtained date which they inputted into these models; how they inputted the information into these models; how they calculated final values from these models and; finally, how they weighted these models against the other models of valuation.
Then, the expert hired by the other spouse will do the exact same analysis using different data, different models, different final calculations and different weights…to arrive at a completely different final business valuation.
It is the divorce attorney’s duty to bolster their expert’s recommendation and tear apart the other spouse’s expert’s recommendation.
The superior expert will give the superior recommendation. The superior attorney will support his expert’s recommendation and diminish the other expert’s recommendation.
The divorce attorney must understand how both the law of business valuation functions and how business valuation functions.
Business valuations for the purpose of divorce are extremely complicated that I can only provide one piece of initial advice to the divorcing business owner or their spouse…does their divorce lawyer own a copy of “Shannon Pratt’s Valuing A Business: 6th Edition: The Analysis and Appraisal of Closely Held Companies?”
If your divorce lawyer does not own a dog-eared copy of this 1248 page tome…I hope they don’t charge very much.
Guess who does have a copy and reads it (hence the quotes above from the book)? Me! So, if you would like to discuss what your business is worth (or isn’t) contact my Chicago, Illinois family law firm to speak with an experienced Illinois Divorce Attorney.