In divorce cases, attorneys will often call upon a business valuation expert to distinguish between “active” and “passive” appreciation when deciding how certain spousal assets should be divided and allocated. The difference is crucial. A spouse’s interest in a closely-held business often represents the most valuable asset he or she owns and is also often the most complex to value for dissolution purposes, particularly if the spouse owned the business interest prior to marriage. In most states (including Florida), the active appreciation of a pre-marital asset is includible in the marital estate while passive appreciation is not. This means that the appreciation in value of the owner-spouse’s active involvement in the business during the marriage is included as a marital asset subject to equitable distribution. On the other hand, if a pre-marital asset increases in value during the marriage due to external market conditions (passive appreciation), it is excluded from the marital estate and remains the sole property of the owner-spouse.
Using real estate as an example, suppose the wife owned an undeveloped piece of property worth $250,000 at the time she married her husband. The property remained undeveloped during the 15-year marriage and was appraised at the time of divorce for $500,000. Since the appreciation in value was solely due to market conditions, it is deemed passive and is not subject to marital division. However, assume now that she had built an office building on the property and marketed it to local businesses so that it appraised for $1,100,000 at the time of divorce. A significant portion of the increase in value would be attributable to the wife’s efforts (active appreciation) and, thus, subject to marital division. If the $1,100,000 property would otherwise be worth $500,000 if undeveloped, the improved value ($600,000) would arguably be considered active appreciation.
With business interests, however, the line between active and passive appreciation can become much more difficult to delineate. After the business appraiser determines the value of the business at the beginning and at the end of the marriage (assuming the value increased over the marriage), he may then consider any passive factors that could apply to the growth of the business. Passive appreciation may be the result of economic or industry growth, legislative or financial (e.g. interest rate) changes, or other market or demographic trends.
Once the business valuation analyst quantifies the amount of passive appreciation in a business interest, the balance of the growth is attributed to active appreciation. However, the valuation work for marital dissolution purposes is not yet done. The business appraiser then must quantify the extent to which the business’s active appreciation is attributable to the active management of others within the organization besides the owner-spouse. As long as there is only one owner/manager, or a clearly delineated set of owners/managers, this quantification is simple. However, the active appreciation lines blur when there are multiple owners or managers all helping in different ways to drive the business’s value. This is where the expertise of the business appraiser truly comes into play.
Distinguishing between active and passive appreciation of a business interest in a divorce can make an enormous difference in the outcome of the case. Using the right business valuation expert can help you navigate through the deceptive complexities of valuations such as this to determine how marital property should be properly divided.