When a marriage ends and a business is one of the assets, several questions can arise as to how the business should be divided, or if it should even be divided at all. Here are several things to consider when dealing with this issue.
Is a Business Considered Marital Property?
It can be. State laws vary, and several factors will determine if a business is considered marital property or not.
If you owned the business before you got married, it is easier to claim the business as separate asset as long as you have taken steps to protect it that way.
This means keeping the business as a separate entity and not commingling it with marital property or bank accounts.
You can also keep it as separate if you can convince your fiancé to sign a prenuptial agreement or a postnuptial agreement after you are married.
When a business is set up as an LLC or a partnership, or put in a trust, that may also provide protection as well.
Your spouse’s role in the company will also be a determining factor as well.
If you started the business after you got married, your spouse made major contributions to the business, or you commingled business assets and funds with your marital assets and accounts, then the business will likely be considered marital property and will be subject to asset distribution laws for your state when you get a divorce.
Is my Ex-Spouse Entitled to a Part of my Business in a Divorce?
Depending on your circumstances, it’s possible.
The first thing that needs to be determined is whether your business is considered marital property or separate property.
Marital property is generally any property or assets acquired during the course of a marriage, unless through inheritance, a gift or an agreement specifically stating an asset was separate.
Separate property is property owned prior to a marriage or property acquired after the date of separation.
In some states, a business may be considered both separate and marital, depending on if a business that was separate grew in value during the marriage due to the contributions of the spouse.
Legal considerations, such as setting the business up as a partnership or an LLC with other partners may also preclude ownership of the business by the spouse.
Once a determination has been made, then the business must be valued. There are several methods for doing this.
If a business is considered marital property, then in community property states, the spouse will be entitled to a 50/50 split of the business as an asset.
In equitable division states, the amount a spouse receives will vary based on a number of factors.
It is possible to negotiate a settlement where a spouse relinquishes interest in the business in exchange for other assets, such as the marital home, retirement accounts, or a cash buyout.
When a spouse asks for alimony or child support payments, this may also have an impact on a claim for part of the business asset as well.
What are the Common Ways for Dividing a Business in a Divorce?
Deciding how to divide a business in a divorce can be a tricky matter because the value of a business as a marital asset can be difficult to determine.
There’s also the consideration of how the division will impact the health of the business.
Typically, couples engage in three possible strategies when it comes to distributing a business interest in a divorce. They include:
Buy-Out. This is the most common method and just as the name implies, one spouse buys out the other spouse’s interest in the business.
If it is determined that both spouses are equal partners in a business, then the division is simple…in theory, at least.
One spouse will need to either pay the other spouse 50% of what the business is worth or concede an interest in another asset (perhaps a family house or a retirement account) as a means of equalizing the division of assets.
A buy-out typically only works when the spouse taking ownership is able to transfer a lump sum owed to the other spouse.
However, in some instances if an agreement can be reached, then it may be possible to structure a buy-out over time.
It’s important to keep in mind that in equitable distribution states, how a business is divided may be interpreted by the courts in a completely different way, taking into account a number of factors that could materially impact how much of the interest in the business each spouse receives.
Co-Ownership. Another way to divide a business is to not divide it at all.
Under co-ownership, both spouses will continue to jointly own a business.
Depending on how amicable your separation or divorce is, both spouses may continue to work at the business, keeping all business arrangements intact.
If a situation is less amicable, then both spouses may keep the interest in the business, but one spouse may become an absentee owner and accept payments only to satisfy his or her share of the marital assets.
For co-ownership to be viable, a certain amount of respect and trust needs to remain between the couple.
Sell the Business. In other cases, the easiest and cleanest way to divide the assets of a business is simply to sell it.
This provides a complete break in the marital affairs of each other and is also commonly done with other marital assets (such as a home) as well.
One of the drawbacks to going this route is that it can take months to sell a business, especially if the business is not financially healthy at the time it goes up for sale.
The other impediment is that many smaller businesses are also a direct reflection of the amount of work, effort and sweat equity of the owners, and it could be hard to find another owner who shares the same level of passion as the current owners.
Another drawback is that one spouse may be much more emotionally tied to the business than the other and will resist any attempt to sell off the business.
The can happen when one spouse is the primary contributor to the business while the other spouse is involved less but keeps other parts of the marriage in working order, especially when children are involved.
There may also be resistance to selling the business if economic conditions have depressed the value of the business, making a sale less attractive that in a robust economy.
There may be pushback by one spouse to hold on to the business until it is a more attractive and healthy venture for a buyer.
What are the Common Methods for Valuing a Business in a Divorce?
Before a business can be properly divided in a divorce, the value of the business must be determined first.
There are three primary methods used to determine the value:
The Asset Approach. This uses a simple formula to determine the value.
It is Assets minus Liabilities equals Value. Assets will include both tangible and intangible assets.
Tangible assets will include inventory, infrastructure and any other physical assets.
Intangible assets include intellectual property such as patents, accounts receivables and other assets that are not physical assets.
While the Asset Approach sounds simple in theory, in reality, it can get complicated.
Some assets, are easy to place a value on, but other assets that may be depreciating or have limited open market value may be difficult to assess.
Inventory can also be problematic as well because it is normally valued at cost but may be worth less than that due to the age and type of inventory.
Unrecorded assets and liabilities can also create accuracy issues as well.
The Market Approach. This method determines the value of a business by comparing it to other similar businesses that have been sold.
It’s a lot like the method used by realtors to determine the value of a house by looking at what comparable houses have sold for in a neighborhood.
Finding a direct comparable between businesses can be difficult if no similar businesses in close proximity have been sold over a period of time.
The Income Approach. This uses historical business information and formulas to predict what cash flows and profits will be for a business as a means of placing a value on the business.
It is the most commonly used method to determine the value of a business.
Sometimes, attorneys will be able to reach consensus and place a fair value on the business, especially when the business is small and does not have a complicated business model.
At other times, it may be necessary to hire an expert such as a Certified Business Appraiser to help fairly value a business.
In cases where a large business is involved, both spouses will typically hire their own appraisers which can lead to nasty legal arguments that could wind up in front of a judge to decide the outcome.
Does my Ex-Spouse Have an Interest in my LLC in a Divorce?
The answer to this may depend on where you live since divorce laws and LLC ownership vary from state to state.
The other big factor is when you formed your LLC.
If you formed it before you got married, then it is easier to claim that it is a separate asset and not a marital asset.
Even so, you must be able to show that an LLC or corporation formed prior to marriage was not commingled and became marital property.
This means taking appropriate steps at all times to document that it has remained a separate asset prior to and during the marriage.
One of the ways you do this is to keep any business profits in a separate bank account, and only put funds into a joint account that you are comfortable with becoming a marital asset.
Who Should I Consult with Regarding Business Assets in a Divorce?
Many business owners believe that retaining a family law attorney, including what to do regarding business assets, is the only expert they need to consult with as they work through a divorce.
While family law attorneys can bring considerable skills to the table, because a business may be the largest asset on the table during a divorce, it is a much more prudent and smart strategy to retain the services of other highly qualified specialists to assist with this issue.
Protecting a business interest in a divorce, properly dividing a business asset in a divorce, and making sure you do it in a way that protects your interests to the highest degree possible are best served with the help of other trained professionals.
Your best bet is to retain a business valuation expert that specializes in divorce. There’s a number of business valuation credentials. Some of the most common include Accredited in Business Valuation (ABV), Certified Valuation Analyst (CVA), Accredited Senior Appraiser (ASA), and Certified Business Appraiser (CBA).
The accepted business valuation methodologies used in divorce vary state to state.
For this reason, you’re going to want to work with a valuation expert that understands family law.
I’d also suggest working with a financial advisor who specializes in divorce.
Your best bet is to retain the services of a Certified Divorce Financial Analyst (CDFA) who is also a Certified Financial Planner (CFP). A CDFA has specialized training in the financial and tax aspects of divorce, while a CFP has broad expertise across all facets of financial planning.
Not only will this professional be able to add appropriate perspective to your situation, they will also be able to take an active role in helping you fully understand the long-term impacts of your decisions.
Armed with this information, together you’ll be able to evaluate and craft settlement proposals that protect you and your business interests to the highest degree possible.
If you believe that a spouse may be hiding business assets from you, then you may also want to consider hiring a forensic accountant to assist you in determining a spouse’s true income and assets.
How do I Protect my Business from a Divorce?
There are several strategies a business owner can take to insulate themselves from the impacts of a divorce.
The most common of these is through a prenuptial agreement.
This is a binding contract agreed to by both spouses that is executed before a wedding.
It defines what happens to all assets, property and income from a business in the event of a separation, divorce or death.
Prenuptial agreements have become more popular because many people are waiting longer to get married than previous generations did.
Because of this, a spouse may have more assets and a much stronger established business at the time they get married.
Protecting assets and interest becomes more critical than ever under these circumstances.
Prenuptial agreements must include the disclosure of all assets and be entered into free of duress or coercion, otherwise the agreement may be thrown out.
While this exercise may make some couples uncomfortable, in reality a prenuptial agreement is designed to head off any arguments in the cases where spouses ultimately decide to get a divorce.
It is best to have each person retain an attorney to make sure the agreement is valid and each side’s interests are protected.
Although less popular, another possible way to protect business interests is through the execution of a postnuptial agreement.
This is an agreement similar to a prenuptial agreement except that it is signed after you get married.
Postnuptial agreements are more closely scrutinized by judges and are not recognized in every state, so it’s best to really do your homework if you’re considering going this route.
In many cases, postnuptial agreements are put in place to supersede an existing prenuptial agreement.
This happens when a financial situation changes because the nature of a business has grown, changed or branched out, clouding the terms of an existing prenuptial agreement.
There are also several other ways you can protect your business in a divorce as well.
These may not totally prevent a divorce from impacting the business, but they may be able to lessen the blow if implemented.
First, consider structuring the business as a partnership, LLC or by creating a shareholder or buy/sell agreement.
These types of structures and agreements can include provisions that protect the other owners if one owner gets divorced.
An agreement could be structured in such a way that an unmarried shareholder must provide the business with a prenuptial agreement before they get married.
This agreement could also include a provision that a future spouse agrees to waive any and all interests in the business when they get married.
Another protection may involve the purchase or transfer of shares to existing owners in the event of a divorce so that control of the business remains intact.
Another possibility is to place the business in a trust.
This prevents it from being counted as a marital asset since you no longer personally own it.
As a means of protection, make sure that you pay yourself a good salary instead of investing all cash flow back into the business.
Doing so prevents your spouse from claiming that you did not contribute to the household during the marriage and may put them in a more favorable position when it comes to a distribution of assets.
An obvious way to protect your business is to be prepared to sacrifice your interest in other marital assets in exchange for retaining either complete control of the business or a much larger share than might otherwise be the case.
You could relinquish control of the family home, retirement accounts or other major assets in return for keeping your business intact.
To remove your spouse from the affairs of the business, you may need to get creative.
Instead of having a spouse as a partner, you could sell the amount of the spouse’s claimed share to an angel investor or offer to sell partial ownership to employees instead.
In some cases, if a spouse is amenable, you may be able to buy out the spouse over time using future profits from the business as collateral.
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