As an experienced family lawyer in Los Angeles can attest, community contributions to separate property can pose an interesting challenge during the time of a divorce. If one spouse owns a business prior to marriage, or starts a business during marriage with separate funds, the business is that person’s separate property. In a community property state such as California, any efforts (i.e. time, labor, skill, etc…) made by the other spouse during the marriage are considered community efforts. Therefore, the community earns an interest in the business. Upon divorce, California law states that the community is to be awarded some of the money derived from the ‘separate property’ business.
How do I determine the community efforts in a separate property business?
There are two steps in determining the community efforts in a separate property business.
Step 1: Valuation of a Business
First, the business must be valued. To value the business, add  tangible assets,  accounts receivable/payable, and  goodwill at the date of separation.
1. Tangible Assets: items that the business owns (e.g. furniture, desk, computer, copiers, etc.)
– Value each item at fair market value at the date of separation
2. Accounts Receivable/Payable: what is owed to the business and what the business owes
– Consider contingency fees (e.g. lawyers paid after trial or doctors paid by insurance)
3. Goodwill: anticipation of future patronage based on community standing (e.g. reputation)
– Value of one’s business beyond value of tangible assets, capital stock, funds, or property
– Every valuation of a business must address goodwill to see if it is possible to quantify reputation, but need not find that there is a goodwill value
– Goodwill may be from [a] the type of business it is (e.g. name recognition of franchise) or [b] the person who owns the business (e.g. owner’s reputation)
– If goodwill is for the owner’s reputation ([b] above), find the difference between the owner’s net income and what a comparable employee would have earned, and multiply it by a factor for how far into the future the reputation earned during the marriage will help the owner
Step 2: Backing Community Property Contributions out of a Separate Property Business
Second, apportion a fair amount of the increase in the value of the business to the community. Courts apply one of two formulas, depending on whether the business is  capital intensive or  labor intensive.
1. Capital Intensive Business: Van Camp analysis . . . favors separate property
– Increase in separate property business is attributed to favorable market conditions or the type of business it is (e.g. name of franchise)
– Reasonable value of services (e.g. cost to pay someone to do the same job) goes to community, and anything more than that is separate property
2. Labor Intensive Business: Pereira analysis . . . favors community property
– Increase in separate property business is attributed to the efforts of the spouse (e.g. time, labor, skill, etc.)
– Value of business at the date of marriage (tangible assets, accounts receivable/payable, goodwill) or initial separate property investment, plus compounded reasonable rate of return (e.g. rate on secured investment) every year is the separate property portion of the business, and the community receives the difference between the value of the business at the date of separation and the separate property portion.
As you can see, valuating a business during a divorce and determining separate vs. community property interests can be challenging. With the help of a Los Angeles family lawyer experienced in business valuation, you can feel confident knowing that you are ending the marriage with what is rightfully yours.
For more information on community vs. separate property, or to discuss drafting a pre-nup that protects your separate property, contact the Los Angeles family law office of Walzer & Melcher today.