One of the biggest challenges a divorcing couple faces is the equitable distribution of their marital property. In other words, answering the question, “Who gets what in this divorce case?”
For business owners, this includes the business they own together. In many divorce proceedings, one spouse often walks away from their half of the business unwittingly. Before this happens, it’s worth discussing what happens to the family business in a divorce.
Many times, the business might represent a vast majority of the married couple’s overall net worth. And because of this, it’s worth looking a little more closely. In any case, it’s important to look a little more closely at the business to make sure that both spouses are getting fair treatment.
Perhaps both partners started the business from the ground up. Maybe it’s a business where all family members are involved.
In some families, the ‘business’ really is the law firm, accounting practice, or some other profession. In this case, the uninvolved spouse didn’t really have much to do with daily business operations. So they might not realize they might be a partial business owner.
Here are six considerations when your divorce involves owning a business.
1. Would the business be considered separate or marital property?
This is a legal question, not a financial planning one. It’s a question that you should seriously explore. Particularly if the business is a valuable one or if the business value represents a significant part of your overall net worth.
And especially if you were the supportive spouse that might not have been directly involved in the business. To better understand this, let’s look at the difference between separate and marital property.
What is separate property?
Separate property is property that one spouse received outside the marriage. This could include items such as gifts, inherited items, or separate property that was brought into the marriage.
For example, a necklace inherited from your grandmother would likely be considered a separate asset.
What is considered marital property?
Conversely, a marital asset is one that is acquired or earned during the marriage. Like a sole proprietorship that one spouse started while the other was working full-time.
Generally speaking, separate assets are not considered when dividing up marital assets. This might not be a big deal when you’re talking about a $500 ring.
However, if you mistakenly assume that a six-figure business is a separate asset, you might be walking away from a valuable part of your settlement.
And don’t count on your spouse to tell you that you’re missing something. You should definitely talk with your divorce attorney to see if your list of marital assets includes the business.
2. What is the business worth?
When getting a divorce, it’s important to know the value of ALL the marital property. While financial assets (like assets and cash) are pretty simple to figure out, it’s more difficult to determine the value of a business.
You should have a business valuation done by a certified business appraiser so you can figure out the business’ value now. But that professional business appraiser can help you estimate what your ownership stake could be worth down the line.
More importantly, what WILL it be worth?
A recent client came to our firm for divorce planning. She and her husband owned 4 businesses together, although he was the one involved in the day-to-day operations.
Since they had children, she was focused on keeping the house. At the same time, she was content to let her husband have the businesses.
Upon a closer look, we discovered that 3 of the 4 businesses were registered in her husband’s name, while one was registered under hers. Coincidentally, her husband’s businesses appeared to be profitable, while hers was losing money.
We were not hired to get to the bottom of this. However, we did recommend that she and her family law attorney look into hiring a forensic accountant. That way, she could better understand the combined value of their business assets, especially her ownership interest.
3. Is the business viable without both of you?
The answer to this might be relatively simple. Or it can be complex.
For example, the owner of a law firm would probably be able to continue her practice without her husband, who works at another job.
But what about a family business, where both partners played an active role in making it successful as a married couple? That might be a little more difficult to figure out. Especially if you had complementary roles.
Let’s imagine a restaurant, where the husband is the chef, and the wife is the general partner. The husband hates managing the books, and the wife doesn’t like to cook.
It might be tempting for the husband to keep going without his wife managing the books. However, the restaurant industry is notoriously tough, and there would be a strong possibility that he could not keep this business viable without her.
If he gives up a lot of other marital property (like an IRA) in exchange for his spouse’s interest in the business, he could set himself up for failure.
4. Can you sell the business to a third party?
Sometimes, the best way to determine properly determine the value of a business is to sell it. Many businesses, especially professional practices, can actually be sold to an outside party.
This might be a consideration if:
- The business is a valuable asset and the fair market value of the business is a considerable part of your overall net worth
- Your business appraiser used a valuation method that overvalues the current value of your business and you feel the market is in peak condition
- Both of you decide that it’s in your best interests to move on and the business is able to operate without either of you.
That last point might be debatable, particularly if it’s a business that you’ve built from the ground up.
However, with the right prospective owner & good management, many businesses or business partnerships can continue without their original owner or founder.
And if that’s the case, a reputable business broker can help connect you to potential buyers. Just like selling a house after a divorce, selling a business often helps both parties move on with some financial stability.
5. What other assets do you and your spouse own?
If you sell the business, that’s great. You and your spouse can negotiate an equitable distribution of the net proceeds and move on.
However, if one of you holds on to the business, then it gets a little tougher.
What does the selling spouse receive in exchange for their share of the business?
In that case, you and your lawyers might be negotiating where the business lies with respect to all the other marital assets.
What if most of your combined net worth is tied up in the business? If most of your combined net worth is tied up in the business, then you should probably be thinking about making sure the business is properly valued.
If your business interest is a small part of your net worth? Conversely, if the business is a relatively new venture, then it might not require as much focus as your other assets. Or if it’s a small business and isn’t worth as much as your other assets, like retirement accounts, investments, or real estate.
Do you have intangible assets as part of the business? What if your business’ value is mostly intellectual property, like trademarks or copyrighted material? How do you properly value those assets?
What if you’re the selling spouse deciding to part ways with the business?
Then you’ll want to consider the fact that a successful business can be considered an appreciating asset, like investments are. Giving up control over the business should definitely be considered in your division of assets.
This contrasts with things that depreciate over time, like cars and furniture.
What if you’re the one keeping the business?
If you’re the one holding onto the business, you’ll want to consider what happens if the business goes south.
So you have two things to consider:
- What does equitable distribution look like in a manner that respects your spouse’s role, but allows you to move forward?
- How do you ensure the business’ viability after the divorce?
If you give up your 401k in order to keep 100% of the business, then you’re placing all of your eggs in one basket. If something happens, you could be left with nothing.
6. What documents do you have in place?
There are two types of documents worth considering.
Do you have a prenuptial agreement in place?
Many people who bring separate property into a marriage ask their partner to sign a prenuptial agreement as part of the marriage contract.
This happens also in second marriages, where one or both spouses want to keep separate property for the benefit of their heirs when they pass away.
Do you have a postnuptial agreement in place?
Similar to a prenuptial agreement, a postnuptial agreement is signed after the marriage takes place.
If you have either of these documents, you’ll want to consult with your legal counsel to get legal advice based on state laws.
Let’s turn to the next category–those would be documents for your business.
Many small businesses, such as sole proprietorships or simple spousal partnerships, don’t have anything in writing. But when business disputes come up, there’s nothing in place that gives formal guidance.
So many successful business owners create formal documents to help guide them through disagreements and other unanticipated circumstances. Like business divorce between the business partners.
Here are some examples of business documents that might help determine the way forward:
- Buy-sell agreement
- Operating agreement
- Partnership agreement
If you and your spouse have written business documents in place, then they should give you guidance.
7. How is the divorce process going?
Is your divorce particularly nasty? Are child support or cash flow key issues at hand Or is it relatively amicable?
The smoother the divorce goes, the better off the business will be in the long run.
And if both spouses are working together, that will help preserve the value of the business so that everyone gets something they want.
The divorce process is never easy. When a couple owns a business together, it makes dividing up the assets for divorce purposes more difficult.
However, for the long-term benefit of both sides, it’s important to take a closer look at how the post-divorce business fits in both of your financial plans. For clearer guidance on your overall financial health, you should talk with a financial advisor that works with divorcing couples.