If you are a business owner on the verge of separating or your spouse just filed for a divorce, you will want to start gathering information about separating your business interests. Undoubtedly, you will ask your family law and business attorneys many questions, and here are just a few.
How will my business be divided in my divorce?
Under California law, your business can be considered an asset of the marriage (community property owned equally by the spouses) even if one spouse owned it before marriage.
It may seem unfair for the court to give 50% of “your” business to your wife or husband if you have put in all the hours, blood, sweat, and tears to make the business successful. But, as you already know, the law, like life, is not always fair.
What if I contributed more funds to start the business?
Upon divorce, you may have an equal interest in the business even though you contributed separate funds (earned before marriage or received by gift or inheritance) into the business to get it started. You will want to consult with a family law attorney about this area if you own a business and are now considering divorce. Your investment of funds may or may not be considered “separate” upon divorce. The structure of your business makes a difference (sole proprietorship? LLC? C-Corp? S-Corp?) Your answer turns on so many different factors!
Some of the questions your attorney will want to know before giving you advice about the division of your business in a divorce are as follows:
1) Did you and your spouse sign a prenuptial (premarital) agreement before you got married that addressed the ownership of the business? Did it address whether income during the marriage would be community or separate income? If so, were you both represented by counsel when the Prenuptial Agreement was signed?
2) What is the business structure, such as a sole proprietorship, LLC, or corporation, and if it’s a corporation, who holds what percentage of the shares?
3) Would one of you want to keep the business and buy out the other person’s share, or have you discussed continued joint ownership?
4) If you want to sell the business, have you spoken with any business brokers about the specifics of your business and whether there is a viable market for someone to purchase it?
While there will be many more questions (attorneys love to ask questions, right?), let’s start with the prenuptial agreement question.
A prenuptial agreement is a contract between a couple before their marriage that sets forth their intentions in writing regarding assets, debts, and income and how these will be treated during marriage in case they later separate. It addresses whether income during the marriage will be considered “community property” (as California law assumes if you don’t state otherwise) or “separate property” (owned individually), meaning the couple wants to deviate from California law.
While these prenuptial agreements (premarital agreements) used to be considered very “unromantic,” more and more couples are getting married for the second time and desire a different way to handle their future should this marriage not turn out as anticipated. If one of the parties has an established family business with his/her children, it may be critical to address the business issues.
Premarital agreements must include the disclosure of all assets and income and must be voluntarily entered by the parties with independent legal representation in order to have the best chance of not being thrown out by the court later. Each person’s interests should be protected to be valid.
If you had a prenuptial agreement that said all income earned during the marriage by the spouse in that individual business remained the earning spouse’s separate property, then that separate business would be more likely awarded to that person if the relationship later came apart. Assuming, of course, the agreement is valid. The business owner spouse would need to be careful not to “comingle” or mix the business assets with any other spouse’s individual funds/assets.
Keeping good records is the best way to protect assets!
What if I didn’t have a premarital agreement, and we both work in the business during marriage?
If the business has grown during the marriage, it likely has a community property value, especially if any growth can be attributed to the help of the other spouse who also works in the business. As you can see, these things can get very complicated! Both spouses have some “community” right to the business because of their contributions and efforts toward the business during the marriage. Sometimes the court looks at the salary being paid to each of the parties and whether the amount paid to that spouse is commensurate with their given job assignment. If so, they may have received what was due to him/her already; if not, then there could be entitlement to more due to extra unpaid efforts.
There are ways that may help untangle or prevent this mixing of separate assets and community efforts, and that is to consider changing the business structure and forming a legal partnership, an LLC, or a corporation. This may help avoid future arguments and protect the other owners if one of the owners divorces.
Will the structure of my business help decide who gets to keep it?
It might help, but it may not be the controlling factor. More facts are needed; for instance, what does the partnership agreement say, or who were the stock certificates issued to, and when? If created during the marriage, sometimes there is a provision in a partnership agreement with others that requires an oncoming partner to have a premarital agreement before becoming part of the partnership, or even a clause requiring that a spouse sign a waiver to his/her rights to any interest in the business. Was that waiver signed by you?
If your business is a corporation, LLC, or partnership, then the ownership shares could more easily define who owns what share of the business. However, even that needs to be clarified for the division in a divorce setting. Spouses working together in a partnership or corporate business, even while owning unequal shares, could end up in a court battle over whether any shares acquired individually during the marriage were really “community” (joint) ownership and should be equally divided. This is definitely complicated!
Is there a way to buy out my spouse and keep the business all to myself?
If funds are available, and your spouse is agreeable to doing so, yes, a buyout is an option. If the parties cannot agree to a value “number,” the business must be professionally valued. If both spouses have been actively participating in the business operations, serious thought should be given to whether one of them leaving the operation would impact its value. Meaning there is goodwill created by that individual’s personality, reputation, and presence that keeps customers coming back.
Please give me hope and tell me if there is any other way to keep my business.
Consider giving up an interest in another marital asset to keep complete ownership and control of your business. Finding the right asset to “trade” can be quite tricky.
When I work with couples in mediation, I like to inquire about their goals and interests. One may be emotionally invested in keeping the house or a pension plan, for instance, and more willing to allow the other to keep the business with the debt or liability that goes with it. Working out the division of a business requires a considerable measure of creativity. Is there anyone else in your sphere of influence that can buy out your spouse’s share and come on as a partner/shareholder? Would a spouse agree to a periodic payment buyout over a number of years? These are just some options to consider.
What about continued co-ownership?
This may or may not work for you. I mean, think about your communication level with your spouse right now… you are likely in a divorce due to a lack of good communication. Even the most cooperative of divorces have found it difficult to continue a business relationship after the divorce. If your working hours had you at the business at different times, or if some of the work could be done at a different location (such as the bookkeeping work), you would be a good candidate for this arrangement.
It is a very personal decision, and there would need to be adequate financial compensation for each of the spouses.
If I have no other choice, what is involved with selling our business?
Selling a business can take several months, especially if it needs to be financially sound. It could be difficult to find a buyer who wants to dedicate as much time and energy to the business you have done because it’s “your baby,” so to speak. The business is only worth what someone is willing to pay for it. Consult with a business broker who can look at your financial statements and survey the other similar businesses in the area to determine a reasonable listing price if you are going forward with this option.
How is the value of my business determined?
Whether there might be a buyout by one spouse from the other or a sale to a third party, in simple terms, the three most common ways of valuing a business are as follows:
- Asset Approach. The value of the assets of the business is less than the liabilities. Assets are generally inventory, business-related equipment, crops, and other physical assets. If you own a winery, then your vineyards are assets. A business can also own intangible assets like patents, copyrights, or inventions. Some assets may have been depreciated over time and hold less value than similar items sold on the open market.
- Market Approach. Comparison of your business to it other similar businesses recently sold. Similar to how realtors compare sales of other homes in your neighborhood. Sometimes it isn’t easy to find a comparable sale of a business similar to yours in a particular area.
- Income Approach. This is the most commonly used process. It is essentially using historical business information (sales and profits) and formulas to predict future cash flows and profits for that business.
It is important to hire a business valuation professional to help determine a fair business value, and experts rarely will come up with the same number but will offer a range of values. For significant businesses, each spouse would secure his/her appraisers, and if they cannot reach a compromise buyout number, the valuation experts will (for a price!) testify as witnesses. The judicial officer makes the ultimate decision of value based on documents and their testimony.
If you need these services, it is important to find a business valuation expert with business valuation credentials such as Accredited in Business Valuation (ABV), Certified Valuation Analyst (CVA), Accredited Senior Appraiser (ASA), or a Certified Business Appraiser (CBA).
Your family law attorney will want you to work with an expert who understands family law, and if you suspect that your spouse may be hiding funds or assets from you, you should also consider hiring a forensic accountant to look carefully into the financial documents of the business.
If you need to talk with a family law attorney about your particular business situation related to divorce, separation, or even an upcoming marriage, feel free to contact my office for a consultation.
-Jeanne Browne, Browne Law and Mediation, P.C.
Family Law Mediator and Collaborative Attorney, JeanneBrowne.com