In divorce cases, where one or both spouses own a business, the value of the business for equitable distribution purposes is often one of the more difficult issues to resolve in the case.  When these issues arise, the Court may appoint an expert. the parties can agree on a joint expert, or each party may retainer their own expert to value the business.   While there are many objective parts of a business valuation report, reasonable (a/k/a replacement) compensation is subjective.  Why is it important?  Because the higher the reasonable compensation, the lower the value of the business and vice versa.  As such, when there are partisan experts, it is not unusual for these subjective factors to favor the party that the expert is working for.

For divorce purposes,as well as many other situations where businesses are valued, they are valued based in whole or part on their income.  Reasonable compensation is a consideration in two valuation methods often seen in divorce cases – the excess earnings method and the capitalization of earnings method.  These methods involve examining earnings available to a potential hypothetical buyer after he or she receives a "reasonably compensation"  for running the business. Earnings available, beyond
"reasonable compensation" are a large factor in valuation. The higher this figure is, the more the business may be worth. In the excess earnings method, the difference between actual compensation and reasonable compensation is capitalized and for all intents are purposes represents the "intangible asset" known as good will of the business.Continue Reading Reaonable Compensation/Replacement Compensation – What it Means to Business Valuation