What Happens To A Business In Divorce?

06 Aug What Happens To A Business In Divorce?

Dealing with a business can be the most difficult part of property division in divorce. It’s not a good idea for former spouses to be in business together; most businesses cannot be split and divided; and putting a value on a business may be expensive and often speculative.

Ex-Spouses in Business

Two people who could not be married to each other ought not be in business together. The personality conflicts that ended the marriage will make working together difficult. Sometimes, spouses will say that even though they cannot be married, they have no conflict working together. In many small businesses, spouses work together in distinct roles and believe that can continue after divorce.

Divorce involves so many emotions and takes so much time that most do not have a realistic view of the future. A common misconception is that life will continue as it was during marriage, but with both spouses single. Actually, one or both will find a new partner. Instead of working with an ex-spouse, they will be in business with the ex-spouse and that person’s new spouse.

Most small businesses are created as an entity, maybe a corporation or a limited liability company. When it was created, a spouse was designated a shareholder or member. Although both may have been designated, one will have a greater interest. After divorce, which spouse will be in control? Who will own 51%? If it’s equal after divorce, the business will probably fail. People who cannot be married should not be equal business partners. Life will change in unexpected ways after divorce. When both cannot agree on a decision, nothing will happen. The business will stagnate.

If one spouse is given operating control that person might ensure the other receives nothing. Instead of paying dividends or taking a bonus, the controlling ex-spouse might increase their salary and pay the other nothing or minimum wage. A lawsuit could be the only option, further harming the business and costing money.

A new spouse will want to know about their business e.g. “Why is the ‘ex’ getting so much of our money?”

Ex-Spouses Owning Part of a Business

It’s common for a spouse to be a partner in a business. Most partnership agreements prohibit transfer of the partner’s interest without the other partners’ consent. Some allow it to be conveyed to a spouse in a divorce decree. However, the spouse of the partner may have limited knowledge of the business and the value of the interest will be diminished if transferred to that spouse. Sometimes, the partner-spouse’s interest can be split between them, with the non-partner spouse playing no part in the business. That is specific to the business.

Dividing the Business

It’s rarely possible to divide a business between spouses. If a spouse holds a percentage in a larger business that interest might be dividable, so each spouse gets a separate piece of the spouse’s original percentage, described above.

If both spouses know all aspects of a business, theoretically each could receive part, e.g. If they own more than one restaurant each could receive a location. Dividing equipment in a single business so each can operate independent businesses raises issues about the customer lists and business connections. The equipment will be of varying quality, age and utility. Lawsuits are almost guaranteed, over competition, exchange of equipment, accounts receivables, paying bills, “stolen” customers, poached employees, etc.

Courts rarely divide a business.

Valuing a Business

The most common way to deal with a business in divorce is to award it to the spouse with the most experience operating it, and award the other spouse equivalent value from the community estate. When there isn’t enough value in the community estate to offset the business, the spouse receiving it makes payments to the other.

Placing a value on a business is difficult and speculative. Like valuing anything, we try to figure out what someone would pay for the business. A publicly traded company is valued by its stock and in that case spouses can be awarded shares. Family held small businesses are typically not publicly traded. To award the spouse not receiving the business an offset we must know the value of the business.

In divorce, we typically deal with “fair market value” which means estimating what a buyer under no pressure to buy would pay a seller under no pressure to sell. This is more than the value of the equipment and receivables. It also involves the value of goodwill and location. Many factors are considered based on the type of business.

Employing Experts

Although an owner may testify about the value of their own property, it’s best to employ an expert trained and experienced in valuing the particular type of business. An owner’s testimony is likely to be self-serving and will be given little credibility.

An expert will need access to all company books, locations and equipment of the business. Usually, the expert will interview the principals in the business. It is an expensive and time-consuming process, and can disrupt the business.

The expert should be credentialed. Some organizations offer credentials to value particular types of businesses. Others are general, like the National Association of Certified Valuators and Analysts and The Institute of Business Appraisers. Within those organizations there are different types and levels of accreditation. It’s essential the expert be properly qualified. If not, they may not be allowed to testify or, if they are, the testimony might be given less weight. The better prepared a party is for trial, the more likely they are to reach agreement. When negotiating an agreement, if one side has a well-qualified expert, they can push for a better deal.

Depending on the value of the business and the other community assets and debts, the spouse to whom the business is awarded could be paying the other for many years. If a business is worth $10 million and there is not $10 million elsewhere in the estate to award the other spouse, the spouse receiving the business can either borrow against it or make payments to the other. Borrowing might not be an option, or the spouse not receiving the business might prefer payments, including the interest.

Selling the Business

Remember, the experts are speculating about what a buyer would pay for the business. The only way to really know the answer is to sell it. That’s rare, but it’s an option available to a judge. A court has authority to order the business sold and the proceeds divided. When a judge makes the unusual decision to sell a business, a receiver is usually appointed. The receiver will prepare the business, conduct the sale, and be paid from the proceeds. Depending on the value of the business, this could be a substantial percentage.

If the business makes money, a judge will be reluctant to sell it because that deprives both spouses of its value. But, if the experts disagree a lot and are equally qualified, it’s an option.

Before You Start

Before making any decision, see an experienced family law attorney. Even if you plan to not have a lawyer in the divorce, consult one early. If you can do so legally, copy the company’s books, starting with QuickBooks or whatever bookkeeping software is used. Also copy all tax documents. Make a list of the company’s bank accounts, including account numbers, and all debts; and an inventory list. Copy the bank statements. All these will be needed to estimate its value.