As discussed previously, once it has been determined that a separate business interest appreciated in value during a marriage, learned treatises and case law often delineate the active passive analysis into the following elements:
- Identifying and quantifying market forces that caused the separate property appreciation.
- Identifying and quantifying the separate property appreciation caused by the active efforts of third party managers, employees or owners (other than the divorcing parties).
- Identifying and quantifying the separate property appreciation caused by the active efforts of the divorcing parties (typically including efforts of either the business owner or the non-owner spouse).
A market force can be defined in general as a measurable economic factor that affects the price, demand, or availability of a product or service. These economic factors can include basic economic factors such as interest rates, population growth, inflation rates, commodity prices or foreign currency exchange rates. In the context of an active passive analysis of a business interest, a market force is more specifically defined, but can include a broad array of factors beyond basic economic factors. For example, a favorable government regulatory change can also be a market force. A market force in an active passive analysis context can be defined as a factor that reflects the following attributes:
- It is a measurable factor that caused appreciation in a separate business interest either during a marriage or between the date of separate (sometimes called the date of filing) and the date of distribution.
- It is a factor that is outside the control of subject company managers, employees or owners.
- It can be analyzed distinctly from appreciation caused by the efforts of individual managers, employees or owners of the business (who might be either third parties or one of the divorcing parties).
For a factor to be a market force in an active passive analysis, there necessarily must be an identification of the relevant “market” on which the factor is a “force”. In the context of an active passive analysis of a business interest, the “market” is typically defined to include a sample of comparison companies exposed to a reasonably similar business environment as the subject company. A study of the impact of the factor on the performance and value of comparison companies helps to identify whether the factor has been a market force during the relevant time period. The business appraiser can then compare the increase in value of the subject company interest to the increase that would reasonably be expected based upon the market force impact on the value of the comparison companies
If the value of the subject company interest increased during the relevant period at a rate that was at or below the value increase of the comparison companies related to the market force, then much or all the subject company value appreciation was likely caused by the market force. On the other hand, if the value of the subject company interest increased at a greater rate than what would be expected from the market force, then the part of the increase over the expected impact of the market force is often attributed to the active efforts of one or more individual managers, employees or owners of the business. To the extent that one or both divorcing parties are among the individuals whose active efforts caused part or all the appreciation during the marriage in excess of the increase expected to be caused by market forces, then that part of the increase is often included in divisible assets.
If you are interested in learning more about how you can strengthen your case with a business valuation expert, or want to learn more about our services and our team, please contact us.