Divorce can become significantly more complex when one or both spouses own a business. Determining the value of that business is often one of the most important—and contested—issues in the case. Courts frequently rely on professional business valuations to determine what the company is worth. However, valuing a business is not always straightforward, and several factors can influence the final number. One such factor is known as a key person discount, sometimes referred to as a key man discount.

Business Valuation in Divorce Cases

When a business is part of the marital estate, it often must be valued so the court can determine how to divide assets fairly. Business valuations are typically performed using one or more recognized methods. These commonly include the income approach, the market approach, and the asset approach.

The income approach evaluates a business based on the income it generates and its expected future earnings. The market approach compares the business to similar companies that have recently been sold. The asset approach focuses on the value of the company’s underlying assets minus its liabilities.

Different cases may call for different valuation methods, and sometimes valuators use multiple approaches together to arrive at a fair estimate of value.

What Is a Key Person Discount?

One factor that can complicate a business valuation is the presence of a key person within the company. A key person discount recognizes that a business may be heavily dependent on a particular individual. If that individual were no longer involved in the company, the business might be significantly less valuable.

In many small or closely held businesses, a single owner or executive may drive much of the company’s success. That person may bring in the majority of clients, manage important relationships, oversee operations, or provide specialized expertise that cannot easily be replaced. In these situations, the business’s value may be closely tied to that individual’s continued involvement.

A key person discount accounts for the risk that the business’s value could decline if that person were no longer part of the company.

How the Key Person Discount Applies in Divorce

In divorce cases involving a business, the question may arise whether one spouse qualifies as a key person in the company. If so, a business valuator may apply a discount to reflect the company’s dependence on that individual.

For example, if a business owner is responsible for generating most of the company’s revenue, managing key relationships, or directing daily operations, the company’s value may be lower if that person were to leave or become unavailable. In such situations, a key person discount may be applied to reflect that risk.

However, disputes often arise over whether the discount should apply at all. One party may argue that the spouse is essential to the business and that the company would lose value without them. The other party may argue that the business has systems, employees, and infrastructure that allow it to operate successfully regardless of any one individual.

The Importance of the Facts

Whether a key person discount is appropriate often depends on the specific facts of the case. Courts and valuators may look at several factors, including whether customers or clients primarily rely on the individual owner, the role the individual plays in managing the business, whether other employees could perform the same functions, and the extent to which the company’s revenue depends on that person’s relationships or reputation.

If customers, clients, and employees strongly associate the business with one individual, the argument for a key person discount may be stronger. On the other hand, if the company has strong systems, management structures, and client relationships that are not dependent on any one individual, a key person discount may not be appropriate.

Why an Experienced Business Valuator Matters

Because the key person discount can significantly affect the value of a business, having an experienced business valuator is critical. A qualified valuator should not only review financial documents such as tax returns and income statements but should also take the time to understand how the business actually operates.

Business valuators who focus only on spreadsheets, income statements, and tax returns may miss important operational realities. If a valuator does not truly understand how the business functions—how clients are obtained, how work is performed, and who actually drives the company’s success—it can be difficult to determine whether a key person truly exists within the organization.

In fact, valuators who do not take the time to learn how the business operates may not be in a position to properly assess whether a key person discount should apply at all. Determining whether someone is a key person often requires understanding the company’s relationships with clients or customers, the structure of its employees, and how work flows through the organization.

In divorce cases involving business ownership, careful and informed valuation is essential. The presence—or absence—of a key person discount can have a substantial impact on the value of the business and, ultimately, the outcome of the divorce.

If you need help with a divorce with a business, Stange Law Firm can help. You can contact our Nashville, Tennessee Divorce Lawyers online or at 855-805-0595.