When couples own a business together, they have that much more at stake in a divorce. Even enough to
put off divorce until a liquidation event occurs in some cases. If divorce is a certainty, here are thoughts
on how to keep, modify, or divide the business. Also, in this blog will be what not to do.
1. Understand its character.
First, understand whether this company is community or separate property meaning, is it even a marital asset or wholly-owned by an individual party? Was the business created or acquired during the marriage? What funds, if any, were used to acquire the business and are those separate property funds? If it was created or acquired before marriage AND able to be traced by clear and convincing evidence, it may be characterized as separate property. There may also be arguments that the community estate or separate estate is entitled to reimbursement. For example, if the separate estate of one of the spouses purchased inventory for the community estate company, the separate estate may be entitled to be paid back for the inventory. (note: Every time I say argument, think $$$$, because that is just a lawyer arguing a side not a forgone conclusion.)
2. What’s in a name?
Whether or not a company is titled in your name, your spouse’s name or jointly together, will make a difference. If the company is a corporation for example, and you own all of the shares in your sole name, you have an argument that the property is sole managed community property and it is therefore more likely to be awarded to you in the divorce. Of course, this will likely mean your spouse will get a like amount of another asset awarded to him/her.
3. Good Will Making.
Let’s say you own 100% of a consulting company, but it’s your spouse that does all the consulting and whose name gets all the referrals. Perhaps, you have all the authority in the world to manage the company, but without your spouse doing the work and knocking on the doors, there is no income to manage. The more important your spouse’s name, reputation and work product to the business is, the lower the company is valued. Further, your spouse could simply quit working for the company you “own” and start their own.
Let’s say you and your spouse hate each other’s guts, but you run a darn good business and you don’t want to stop that side of the ‘er – partnership. Oftentimes, each spouse provides an indispensable value to the company. Think Chip and Joanna Gaines, Beyonce and Jay-Z, Jeff and MacKenzie Bezos (wait -er?). What would Fixer Upper look like without Chip throwing a sledge hammer? Recognize that your brand could be connected to both of you. In this situation, consider amending company agreements and bylaws so that each of you owns an equal amount with tie-breaker provisions and buy-out options should the best intentions fail. Involving a CPA and corporate attorney in this arrangement is recommended, unless you think you can do your own brain surgery too.
5. What Not To Do – Forgo Paychecks.
Many couples have a small business in which both people run the business full-time, but only one spouse earns a paycheck. I get it. It’s another payroll item and a hassle. But when you get divorced, the Court will want to know who earns the money and who does not. A person who does not have shares, units or an interest in the company at all and who also does not draw a paycheck will find they have few grounds to seek temporary control of the property. This means their direct knowledge of the company affairs could be withheld from him/her, cutting him/her off from cash flow and material information needed to value the business.
6. Divorce Planning Back-Fire.
Let me guess, your business was flourishing until right before the divorce was filed? Now the company is under water and should probably wind up? Us divorce lawyers see this all the time. It could be true, but it is very suspicious when the family’s main asset has decreased in value right before a divorce begins. At the same time, the decline in the business could be emblematic of problems in the marriage or one’s personal life. It is important to have good records at least three years back reflecting the business’s fluctuation for the sake of arguing either a temporary dip or a true decline in value. See above about argument$.
7. Being in the Red.
Oftentimes, lines of credit, security agreements and promissory notes are signed by one person in the marriage. This can leave that spouse at a disadvantage when dividing debt. The business may be doing well and in the black, but the guarantor knows that the bank will be pounding down his/her door when the red times hit. Although a divorce court will not necessarily take this into consideration for a number of reasons, it does matter in terms of valuing the property. If the debt is entered into jointly, it creates a more sober and realistic approach to valuing and then dividing assets.
8. DON’T go to Trial.
Every client has an automatic right to trial and a jury in some cases. But DO NOT. A trial judge will not likely secure debt payments, structure buy outs at a fair value, equalize tax liability, require amending operating agreements or otherwise get creative. A trial court will most likely only award property to a spouse or sell property and divide proceeds. Get a good CPA, a corporate lawyer and a divorce attorney who will structure a reasonable and private settlement. Believe it or not, CPAs and lawyers can actually be very creative in this regard. If you want to continue running the business with your spouse but protect your ability to get out (said every business person ever), this is possible with the right professionals.
9. Fraud Considerations.
I used to know a restaurant owner who took cash out of the register to pay for babysitters while they were married. It was a nice perk while it lasted. Can you imagine the amount of self-dealing that could be happening in your family owned business? Generous reimbursements are one thing, socking up faux debts and hiding cash is another. Perhaps the company is cash poor because it gave an unsecured loan to a cousin that has a weak or no explanation for repayment terms. Or perhaps there is an effort to dilute your ownership interest and bring on investor (college roommate) who will have majority decision making. If this scenario sounds like your situation, you may need to sue the company to remove your spouse’s hands from the honey jar, that is if you are also an owner. Again, you will need an experienced corporate attorney and divorce litigator to seek repayment of the fraud, obtain a judgment, or seek a rebalance of your divorce award. This scenario can be a real nightmare in terms of emotional stress and attorney’s fees. It could also be the only way to sort out the extent of the damage. Do yourself a favor and stay involved in the business enough to watch who the checks are being made out to and where the deposits are going.
Buy outs can occur in several ways. It could be in continuation of joint ownership and management pending a sale or election of one of the members. With properly structured paperwork, spouses can be divorced but not divide the business to one or the other spouse until a certain event. As in non-married business partners, when one wants to sell his or her portion of the business, the other partner typically will have an option to buy. The key is to make sure the price is right in that buy out. If that sounds too complicated, a spouse can assign his or her shares or interest in the company to his or her spouse in exchange for a promissory note. What happens if the promissory note is never paid? The promissory note could be drafted in such a way that the shares of the company are held in trust by a third party until the note is paid in full. This will ensure that the payor is motivated to stay current on the notes. Other considerations will need to be made for the risk of the payor filing bankruptcy or diluting shares.
Divorcing can be particularly intense and problematic when a business is involved. Attorney’s fees could be exponential, compared to what they would be for a divorce with simple assets. Reasonableness on both sides is the key to preserving the assets during the divorce.