Robert Bailes | Understanding Business Valuations and Tracing in Family Law

We are pleased to welcome Robert Bailes to the show. Robert is the Founder and Managing Partner of Bailes & Co., P.C. He is a CPA with accreditations in financial forensics and business valuations. His 35 years of experience as a financial expert has primarily been in the area of family law, focused on tracing and valuations.

Robert is extremely knowledgeable of nuances in Texas case law when it comes to the often-painstaking tasks of valuing businesses and tracing assets in family case proceedings. Our conversation details what a family law attorney needs to know about business valuations and tracing, including:

  • What attorneys should look for when seeking a business valuation or tracing expert
  • The basic elements of business valuations
  • Why some assets cannot be traced
  • How to attack a valuation or tracing determination you disagree with 
  • And much more

Get all your business valuation and tracing questions answered today!

Mentioned in this episode:


Robert Bailes: When in doubt, call your expert and say can you look at it and tell me if it’s worth the money. Most of us have plenty to do and we don’t want to work on things that aren’t benefiting people. So I would encourage you just to ask your expert if it’s worth the money and they’ll tell you.

Voiceover: You’re listening to the Texas Family Law Insiders podcast, your source for the latest news and trends in family law in the state of Texas. Now, here’s your host attorney Holly Draper.

Holly Draper: Today we’re excited to welcome Robert Bailes to the Texas Family Law Insiders podcast. Robert has a bachelor’s and master’s degree in accounting from Baylor University, and he is the managing partner and founder of Bailes & Co., P.C. He’s a Certified Public Accountant and has earned the Accredited Business Valuation and Certified in Financial Forensics designations, which are issued by the American Institute of CPAs. Robert has been working as a financial expert in divorces for over 35 years. Thank you so much for joining us today.

Robert: Thank you for having me.

Holly: So why don’t you start by telling us a little bit about yourself?

Robert: Well, I’m a CPA from East Texas. Started practicing in 1978, which seems like ancient history to you. Began my practice with a large East Texas firm, primarily doing tax work business consulting, and a client asked me to step in for him, he was a business broker, to help value a business in a divorce. I had no idea of what he was talking about, but foolishly decided to do it. It was the divorce of a crooked liquor store owner and somehow got into the family law world, unintentionally, and I’ve been there ever since. Still have an accounting practice doing tax and consulting work for small businesses, primarily wealthy families, families that own small businesses. And then probably 60, 70% of my personal time, is doing family law work, primarily tracing and valuation.

Holly: So most people that listen to our podcast would know what a CPA is, but they might be unfamiliar with the other designations that you have. Specifically, can you tell us about the Accredited Business Valuation designation?

Robert: Yeah, Accredited Business Valuation is an American Institute of CPA designation. To get it, you have to pass a test that looked sadly, a lot like the CPA exam, I thought I was through with tests before I took that. And then you have to maintain levels of education and experience to maintain it. We have to keep 20 hours of business valuation minimum education per year. Plus, we have to provide proof to the AICPA that we’re actually doing that kind of work. So it’s been a nice designation.

Holly: And what about the Certified in Financial Forensics designation?

Robert: That’s a newer designation of the AICPA. It really deals more with having the experience working in the area of financial forensics. At the time I got it, all you had to be able to do is show you were Accredited Business Valuation, you worked in the field litigation, and you qualified for that designation. Now you have to take a test. I got lucky enough not to have to take the test, but it’s not as strong of a designation to me as the ABV.

Holly: So today, we’re going to kind of dive into two different topics that are your areas of expertise, those being business valuations, and then tracing. So let’s start talking about business valuations. What should attorneys look for in finding an expert to conduct a business valuation?

Robert: There are several things you want to look for. One, you want to find someone who has experience and knowledge of business valuation. You want to find somebody with a business valuation credential. It doesn’t have to be the ABV there are other ones out there. It’s someone who’s demonstrated the knowledge, someone who has experience doing it. And quite frankly, I think one of the most important things for a Texas divorce lawyer is to find someone knowledgeable of Texas case law as it relates to business valuation. Because there are nuances to values in Texas divorces that are totally different than what you can go sell a business for. And if someone doesn’t understand those differences, they’re going to give you an erroneous value.

Holly: Can you squint a little bit about what those differences are?

Robert: The biggest one is personal goodwill. The case law requires us to value the business without regard to personal goodwill. I guess the easiest explanation for that is maybe the most obvious. And that’s a physician’s practice. Actually, the case that the courts first came out with that is the landmark case is called Nail versus Nail, and it was a physician. So the physician’s practice if he finds another physician to buy it, and he agrees not to compete with it, and to help transition the business over to the other doctor, he might get some money for it, there’s some value to that. But that is the value other if he doesn’t agree not to compete, is the marital value. The other value is his personal goodwill.

So what you find in a lot of businesses is without the owner in there, there is no business and all you have left is some assets, some cash, some accounts receivable, in a bank note. So that’s the most, medical practices, a single medical practice or solo practice lawyer or accountant. It’s almost all personal goodwill. For example, I just left a meeting a guy who has a manufacturing business, and he has relationships to some of his customers that he can take with him. That one’s more difficult. I had to value the business, as if he leaves it, but there’s still millions of dollars of manufacturing equipment, lots of customers that would stay, but it diminishes the value of it when you take his personal relationships out.

Holly: So I want to make sure I understand correctly, when we’re looking at it in a divorce, the personal goodwill is factored in more than if you’re selling it.

Robert: It is taken out.

Holly: Oh, okay.

Robert: You value it as if they’re not in it, and they’re free to compete with it.

Holly: So it reduces the value significantly.

Robert: It’s, in a lot, it’s not going to reduce the value of a McDonald’s franchise. Because no one cares who the owner is, you don’t know who the owner is at your local McDonald’s probably, but you do know who owns the insurance agency you use, or your physician or your dentist. And that personal relationship, the value of the personal relationship is not part of the marital estate. And if someone doesn’t understand that concept, they’re going to overvalue the business.

Holly: So how do you, when you’re conducting a business valuation, account for that value of the personal goodwill?

Robert: A lot of it’s subjective. And if someone tells you it’s not subjective, I would like to chat with them. You determine the value of the business assets. And again, that’s the equipment, the cash, the accounts receivable, you got to pay off the notes, and you got to pay off your trade payables and all that. What’s the net asset value of the business, and then you look at what’s the value of the cash flow of the business, because that can be two different things. The difference in the two is what we call the intangible value.

And that’s where we go in and try to make judgments, and their subjective judgments on how to carve up the intangible value between the business and the person. Sometimes it’s really easy, sometimes it’s really difficult. We had one the other day, we’re the only customer of the business was the guy’s father’s company. Without the guy’s father’s company, there was no revenue. That was 100% personal goodwill. So, you know, you just got to look at every every situation.

Holly: So what are the basic elements of a business valuation?

Robert: It’s not a lot different as far as the elements you look at than you would a real estate appraiser. What does it cost to replace it? What’s its income? What are others like it being sold for? It’s the old asset, you know, the cost approach and the income approach in the market approach. You look at what assets does it own, what liabilities doesn’t have? Mostly what we do is try to determine what is its true cash flow. So normally the value of business is driven by what its cash flow is. And a lot of what we do with small businesses, which is primarily what we’re working with in divorces is try to restate the income without all the personal expenses being paid, with the owner being paid, market level salary, with the building that’s being rented to the business being rented at a reasonable rate.

But restate it is what it would look like. And I always tell clients, as if I bought it, what would I have to pay to replace you? What would I have to pay to rent your property? And what business expenses do you have that I wouldn’t need? You know, how many of your kids are on the payroll that might not be worth what they’re being paid. That kind of stuff. But once you determine the value of the cash, what the cash flow is, and you look at the risk associated with that cash flow, and it’s going to be some multiple of cash flow, the riskier it is the smaller the multiple. The safer it is, the bigger the multiple.

Holly: So what is the range of multiples on this?

Robert: Wide range. Probably most are going to be within three to six times cash flow.

Holly: And when you say cash flow, are you looking at, is that basically gross income?

Robert: No, I’m talking about after all the expenses are paid.

Holly: Okay.

Robert: So in another one, another way you can look at is EBITDA. And that’s a term that’s you, you’ll read earnings before interest, taxes, depreciation and amortization. A lot of times they sell for a multiple of EBITDA, and that’s usually three to six times. We look at it a lot of different ways. But I think if you look at that range, it’ll give you an idea of what most your value is going to come at, come in at. And you got to take the debt off.

You know, and sometimes you have excess cash, you got to add in. You know, or you’ve got a house in Lake Tahoe, and it’s got nothing to do with the business, you have to add back into it. Yeah, so you got to look at, that’s what the operating assets of the business are going to be worth. And then you look at it and say what else is out there? Becuase a lot of them have things that are not operating assets.

Holly: So let’s say as a divorce attorney, you know, the opposing party has a business. We, a business valuation is done, and we think it is either probably too low in that scenario, his attorney is gonna think it’s too high. How do you attack a business valuation if you disagree with it?

Robert: Well, what I prefer to do is see if there’s some middle ground between the two, and take a look at what assumptions were used. Do we agree with the assumptions the other party used? And it’s going to normally be based on what income did they use to determine it? They might have used a different income number, because you do have to add back all the personal stuff. You do have to take a look at what kind of revenue do they have? How many customers do they have? How risky is it? So you look at what’s their real income?

And you look at what the capitalization rate, which is really what derives the multiple, what risk levels did they apply? Those are usually the levers that are going to create differences in the two valuations. And most likely, the difference in the two valuations is going to be how do they address personal goodwill? What I found is most of the time, our entity values are pretty close. But where we differ might be in the personal goodwill, because it’s so subjective.

Holly: What type of information do, does a party, business owner need to provide in order for you to complete a thorough business valuation?

Robert: Everyone’s different, but the core information is going to be normally five years of historical tax returns, financial statements, depreciation schedules, if you have an organization chart, and a lot of the ones we have are not sophisticated and they don’t have things like an org chart. I like to get W2s of the owners and all the family members. I like get 1099s through money paid to owners and family members. The one I meeting I just left I asked for the revenue each year from the top 10 customers. So I can see how concentrated the sales are. In that case, maybe 50% of the sales is one customer, which makes it much riskier.

Then after we get into it, we’ll run analytics with those that data and then other questions will pop out about how the business is operated, what the market is like. In the best cases, we get to interview the management, that doesn’t always happen. And then you have to do the best you can. But we like it when we can interview the management. What I like to do is get me and the other expert to interview management together. And sometimes the attorneys will let us do that, sometimes they don’t. Some clients are willing to do that, some clients are not. But that gives us better data. And we’re less likely to have a big variance in the value.

Holly: Do you rely entirely on data that you’re receiving from the business owner? Or do you independently seek out any additional data?

Robert: Well, we independently look for information about the market that they’re selling to. We have databases that we subscribe to that gives us what’s the current status of that market, what’s going on in that market. And a lot of that goes to what’s the risk associated with cash flow. But to a large extent, we have to rely on the information we get from the business. And sometimes we’re uncomfortable with it. I mean, there are cases where we say we can’t do it. Because we don’t think the business data is reliable. It happens more often than I would like it to.

Holly: What is something that would make you think data was unreliable?

Robert: The last tax return filed was 2018. They don’t have a general ledger. They don’t keep any kind of books, their books are a yellow pad. And we see that, especially with these cash based businesses, it happens quite a bit. The more sophisticated businesses all have accounting systems and CPAs that do financials and we feel good about those, but the ones that kind of scratching on the back of a pad, we’re not real comfortable with.

Holly: Do you typically take tax returns and that sort of information directly from the business owner? Or do you get it independently from the IRS?

Robert: Almost always from the business owner. It takes a long time to get it from the IRS. Sometimes we have to go that direction. Normally, we can get it from the business owner or the CPA. Most of the businesses were working on are not making $50,000 a year, they’re larger businesses. And they have accounting systems and CPAs that are going to give us good data. The smaller ones sometimes are a little more frightening.

Holly: I’m sure. So our podcast is targeted to family lawyers. So if you could give advice to family lawyers, when it comes to business valuations, what would be your top advice?

Robert: Get the data to your expert, listen to your expert, make sure he understands or she understands everything you and your client know about the business. Don’t just throw him a bunch of documents and assume he’s going to pull it all out. We need to be educated, we need to know what our client knows. And that will help you a lot. The records are very important. We’re not asking for things that we’re not going to use. So get us the information, get us your knowledge. And another thing is don’t believe everything your client tells you.

Holly: Yes, I think we I think we have all learned that one.

Robert: Well, I don’t know if all of you have learned that!

Holly: Very true. Very true. Okay, so shifting gears a little bit. I also want to get to the topic of tracing. I think that’s something that all family lawyers know exists, but not all family lawyers know exactly what it is and how to do it and all of those things. So can you just tell us generally what is tracing?

Robert: Well tracing is where we try to take the separate property, whether it’s owned before marriage, inherited or gifted during marriage, a personal injury award during marriage, whatever it is, created the separate property, and trace it through the accounts from inception to title forward to the current inventory of the parties. We’re seeing more and more of it. We’re seeing it in the baby boomer generation, which sadly is me. More of us are dying and we’re leaving assets to people that are getting divorced. And it’s, I’d say, if there’s a trend right now we’re seeing more and more tracing. In the cases, we’re working on. The need for it. A lot of it is retirement accounts that people had before they got married, because people are getting married later.

So they began working before they got married, and they were participating in retirement accounts. And that would be have separate property aspect to it, plus the inheritance. But we, to trace, you really need all the records, and it is a record intensive process. And we generally try to get all the brokerage statements, not one or two, not just the one before marriage, not just the one now, all the ones in between. All the bank statements. And we go in and reconstruct all the activity in those accounts, to see where the money went. And then we follow the money trail. And a lot of times, it’ll bounce from one account to another account to another account.

Or with securities, people are constantly repositioning their portfolios, and it goes out of one stock into another stock into another stock. So you, it’s basically a follow the money program. With cash, the Texas courts, like using what we call the community out first process, which assumes that the first money spent out of an account is community money, and the last dollar spent is separate money. I compare it to oil floating on water, that the oil gets spent first in the water gets spent second. And that’s that’s how we traced the detail inside the account, normally. There’s other methods but 90% of the time or more, it’s community out first.

Holly: Do you generally rely on the party and the attorney to obtain all of those statements and records? Or do you go back and obtain what you need based on what you see?

Robert: Well, normally, we don’t get the records. We work with the attorney to let the attorney know what records we need. Yesterday, I had a meeting with an attorney and it was what accounts do we need to subpoena because we’re not getting them? What companies matter, because we don’t want to be spending the money serving subpoenas that we don’t need. So we spent a couple of hours going through everything, identifying what to subpoena so we could get the records we need to do two things. One, identify some assets, and two, trace them. So but normally, it comes to us through discovery. And when we are having issues with discovery, we get it through subpoena. Obviously, the expert doesn’t have the power to do that. So we got to work with you guys to do that.

Holly: How far back are people typically able to get records? I know with, you know, online, usually you can go back a year, maybe two, but going beyond that, you’re gonna have to get them directly from the bank or whatever entity held the funds. Is there a limit to what you’re gonna be able to get from them?

Robert: Very much so. And it can be a real problem. Every financial institution has its own document retention policy. Even though they’re electronic documents, they seem to not be able to produce them more than five or six years worth of documents. We run into this all the time. And if you have an unexplained gap in your record, you’re not going to be able to trace it. So sadly, a lot of things cannot be traced because we can’t get ahold of the records. Even though you know, it’s there. You know, it’s in a retirement account had $200,000 in it 2005, but we don’t have any records between 2005 and 2017. We can’t show what happened in between. Most courts aren’t gonna give it to you. And there’s a case out there now that says you got to be able to explain the gap.

Holly: I think most people now don’t keep all those documents, especially the longer people have been married, the less likely it is that they’re going to have documents to go back throughout the marriage into before the marriage.

Robert: You’re right. Although we did one that we did 35 years of a very, very wealthy couple. And they had every bank statement. Every general ledger every check, every oil and gas check stub. 35 years. So you never know, most clients don’t have that. And the frustrating part for the client is, they don’t understand that they have to have that entire group of documents to prove it up, they think all they can have to do show you a statement right before marriage. And it’s hard to get it across to them that that’s not enough. But getting records to trace is the most challenging part of doing a tracing.

Holly: So if obviously, tracing is significantly more complicated when we have commingled funds or money going in and out from various sources, some separate, some community. Is tracing necessary, or are there circumstances where it would be necessary if somebody’s separate property has always been kept separate?

Robert: Well, all you got to do is pull the deed up and show that the inception of title was before marriage, or it was a gift deed, or it came from an executor of an estate. That’s the easy stuff to trace. But what we’re what we normally see is tracing of investment accounts. Most people have 401Ks, most people have brokerage portfolios. And that’s where all the detail comes into play. Or someone’s just very active investing their money. And you got to trace through all the bank accounts to see where the money came from to buy the piece of real estate or to invest in the company or whatever. But yeah, a lot of it, all you got to do is trace it back to that inception of title to a deed or whatever. And it’s real simple.

Holly: So as attorneys, when we are looking at a tracing report, what are some red flags that we should look for if we’re trying to attack those findings?

Robert: Look at the character of the deposits. And can the character the deposit be supported? So $500,000 went into the account and that was a gift from mom. What do you have to prove it’s a gift from mom? Well, if mom’s dead, you don’t have mom’s testimony. So did mom file a gift tax return? Is there a letter from mom, some kind of document showing that was a gift? Or is it just your client telling you it was a gift?

So how well supported are the deposits, the character in the deposits, because that’s really what drives the community out first tracing is the character of the money that comes into the account. And then did they trace, and I’ve seen this, did they trace inside of an entity. You can’t trace inside of an entity. And I’ve seen tracings community out first tracings of an LLC account. When the money goes into the LLC account, it belongs to the LLC, it loses its character. It’s not community, it’s not separate. It’s LLC money. You can’t trace inside the entity.

If you see the tracing of the corporate account or an LLC account, or limited partnership account, there might be a problem, there probably is a problem. But the biggest is how well supported is the character of the deposits. And just, if you’ll focus on the deposits, you can determine real quick whether you agree with their tracing or not. And, you know, most of the experts in the Metroplex, do a good job and do good honest tracings. All you do is go check them out, make sure there wasn’t an error in there. But every now and then you see some crazy stuff. So you got to watch for it.

Holly: So one of the things that we struggle with when dealing with property division, is knowing how much makes it worth hiring an expert for tracing. Because obviously, if your estate or your separate property claim is not over a certain threshold, it’s not going to be worth the cost of hiring a tracing expert to prove it. So where would you see that line of when it’s time to start looking into an expert?

Robert: What I like to do because I don’t really have a threshold is but if, if you’re concerned about it, and I had this happen a lot, people call me up. I’m doing one right now. I don’t know if it’s worth hiring you. Send me the documents. Let me look at the documents and see how many hours is it going to take to do this. And I’m going to charge you to look at the documents. And let’s make sure that if you hire me, you’re making money off of me. And I’m not a cost to you. That’s the way I like to approach it.

And then every situation is different, because you might have $200,000 account that you think’s worth tracing. But it’s what’s called a managed brokerage account where they do 20 or 30 trades a day, you can’t trace them with economically, because there’s too many transactions. But you may have a $10,000 account that you can trace in two hours. Yeah, might be worth doing. So, you know, every situation is different. It all depends on how long period of time are you covering? How many transactions are involved in the accounts that are being traced? If it’s like a retirement annuity, that’s a very quick process.

When were you married? When did you start working for the company? When did you retire? Or what’s your age? And it’s just a formula. So that’s just a very short period of time to do that characterization. So when in doubt, call your experts and say can you look at it, tell me if it’s worth the money. Most of us have plenty to do and we don’t want to work on things that aren’t benefiting people. So I would encourage you just to ask your expert, if it’s worth the money, and they’ll tell you.

Holly: So back to my advice question I like to ask about, I like to ask everyone on the podcast. What advice, what’s your top advice that you would give to family lawyers when it comes to tracing?

Robert: Um, that might be it. First, if you can’t get the documents, it might not be worth pursuing. If you have a question, ask the expert if it’s worth it. If you can do that, that’ll help you a ton. It’s first the documents though. If you can’t get the documents, it’s not gonna do any good. And I have that a lot. I need you to trace this, well, I need these documents. While I can’t get them. Well, what am I going to trace from? So always remember, put yourself in the shoes of the expert that’s under cross examination. Becuase when we’re working for you, everything I do, thinking about that cross examination question, and I’m going to try to bolster whatever I’m doing to be able to withstand a good vigorous cross examination. If I can’t do that I’m probably, well, in my mind, I’m not going to give you an opinion.

Holly: So do you help attorneys, speaking of cross examination, do you help attorneys with figuring out what to ask the opposing expert on cross examination?

Robert: Sure, sure, we take a look at the reports. We let them know if we agree with them or not. If we disagree, what I like to do is try to find what are the top two or three issues that I disagree with that really matter? As opposed to nitpicking somebody’s report, page by page. And then say, here are the here are the levers that make a difference that you need to ask questions about. And here’s where we differ. And get that across. And again, trying to put myself in the judge’s shoes. What do I really care to hear about this? I don’t want to hear a bunch of nitpicking. I want to hear about what really matters. So we try to get you that information. I’m not one to give you pages and pages and pages of questions. I think that just drags things out that no one wants to hear.

Holly: I wish some lawyers had that philosophy too. So where can our listeners go if they want to learn more about you?

Robert: Ask around probably. I don’t do a lot of marketing, so we probably work, I don’t know with 100 different lawyers. So most of the folks in the Metroplex probably know a little about me. Positive, negative, I don’t know. We do have a website bailesco b a i l e s c I don’t know if it tells too much about me, but that’s what I got. That’s about all the marketing I’ve got.

Holly: Well, it seems to be working well enough.

Robert: Yeah, we’re fortunate.

Holly: Well, thank you so much for joining us today. We’re just about out of time. But for our listeners if you enjoyed this podcast, take a second to leave us a review and subscribe so you can enjoy future episodes.

Voiceover: The Texas Family Law Insiders podcast is sponsored by the Draper Law Firm. We help people navigate divorce and child custody cases and handle family law appellate matters. For more information, visit our website at

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