The thought of divorce is never one that seeps into the thinking of couples on their wedding day. They are enjoying the bliss of their special day and the fact that the United States ranks sixth among countries with the highest divorce rate in the world is lost among bridal dances and congratulatory toasts.
The reality is that the divorce rate for first marriages is in the United States is 41 percent. Divorce can tear apart families, negatively impact children, and cause upheaval in many areas of a person’s life, including their professional one.
One of the most contentious aspects of a divorce proceeding involving a privately held company is determining the value of the business. Many a productive, profitable company has been brought to its knees because of a divorce and its employees and customers left wondering what they did to end up in the middle of such a bitter dispute.
Laws vary by state but depending on your specific circumstances, your spouse could be entitled to as much as half the value of your business. For entrepreneurs who invest their blood, sweat and tears into their business this can be a difficult pill to swallow.
Whatever the reason behind the dissolution of the marriage, small business owners stand to lose their livelihood and negatively impact the fortunes of their employees and vendors, as well.
To protect your professional snow and ice management operations from the stinging financial impact of a divorce business and legal experts agree that the devil is in the details and that advance planning can be a life and business saver.
Protecting your business in the event of divorce starts with a good dose of planning well before you or your spouse have decided to end your marriage. From prenuptial agreements to buy/sell agreements, all need to be done well in advance.
Understanding the differences between separate and marital property is also important. Please note there are differences in the legal definitions of what constitutes separate and marital property from state to state, but in general separate property can include:
The don’ts of divorce
Inheritance that is received by one spouse only.
Any property that was owned by one spouse before being married.
A gift received by one spouse solely from a third party – not from the other spouse.
The pain and suffering portion of a personal injury settlement received by one spouse.
“What you must keep in mind is that the business is an asset – whether separate or marital – and it will have to be characterized and valued before the divorce process is completed and a settlement is reached,” says Janice Green, a veteran family law attorney based in Austin, Texas.
Property that you brought into the marriage can lose its separate status when it is combined with marital assets, Green says. For example, if a spouse used an inheritance or monetary gift they received to help start, fund or pay off debt in a business. This would then make the money a marital asset and it could be argued that half belongs to your future former spouse.
Another example would be property – a house or condominium – that was purchased by one party before the marriage and then re-titled to include the other spouse’s name.
“If the money or other asset benefits the business in any way it could be viewed as hybrid and the source where the money came from could be entitled to a share of the business,” says Green.
By general definition marital property consists of all income and assets acquired by either spouse during the marriage. This can be a long list and includes, but is not limited to:
- Pension plans, 401(k)s, IRAs and other retirements plans
- Bonuses and commissions
- Annuities and life insurance
- Mutual funds, stocks, bonds
- Bank accounts – checking and savings
- Real estate, cars, boats
- Real estate
- Tax refunds
- Limited partnerships
- Closely held businesses
- The Prenuptial Agreement
A prenuptial agreement – usually not the first item on a newly engaged couple’s to-do list – can save business owners a whole lot of heartache down the road.
The agreement is a legally binding contract that explains in detail what the couple’s property rights and financial expectations (including alimony) would be in the event they divorce. It explains what the couple agrees upon is separate property and what is marital property, and how it will be divided.
The strength of a prenuptial agreement is that a well-written document can override community property and equitable distribution laws. State laws differ of course but courts typically respect a prenuptial agreement and follow its recommendations.
“A well-written pre-nuptial agreement can avoid a costly property characterization battle in court,” says Green. “It can also establish a methodology or formula for how the business will be valued, how the business will be managed or who gets the business outright.”
What NOT TO DO in a divorce
Janice Green, a 37-year veteran attorney of divorce battles that involve small business owners and their families, says there are some simple, straightforward dos and don’ts business owners will want to follow during the divorce process.
Green says being transparent and truthful with all business and financial information, and keeping your spouse and their attorney informed is a must.
“Everything is examined closely in the divorce process and it is wise not to spin webs or you will end getting snared in them and it will cost you dearly,” she cautions.
For the prenuptial agreement to be recognized it must be well-written and researched, and each party should have their own attorney review the document. Some pre-nuptial must-haves include:
- It must be in writing (no verbal agreements), signed willingly by both parties and witnessed by a notary.
- All assets must be included in the document or it will be ruled invalid.
- It has to be a fair document and cannot blatantly favor one party.
The Buy/Sell Agreement
Buy/sell agreements usually come into play during divorce proceedings when the two parties want to make sure the business stays solvent and operating as if nothing happened. These agreements should be in writing, prepared by the attorneys, and as detailed as possible.
The agreements can cover virtually any business related detail from the length and terms of the payout to detailed management agreements, job descriptions, compensation, and work hours should the two parties agree to continue to work together.
Green encourages her clients to include language that addresses all the details – both for the short and long-term.
“The agreement should be written with an eye to the future and take into account situations where spouses remarry, have children with their new spouse or simply have a change of mind and want out of the business,” says Green. “The document should set the expectations for both parties and eliminate any confusion. Where there is confusion there is anxiety and that usually ends up costing someone.”
Paying Your Spouse Off
Aside from the emotional toll, the hardest part of a divorce is often paying your spouse their share following the final court judgment.
The distribution of payment to a former spouse has pushed many businesses up to or over the brink of survival. Just how do you go about settling up with your ex-spouse? Business experts recommend the following:
- Sacrifice your other assets. In the settlement forfeit other assets including investment accounts, cash, real estate, retirement funds or other property to maintain 100 percent ownership of the company. It may be tough going in the short-term but your business is your best source of income and you want to protect it.
- Set up a payment plan. Negotiating a long-term payout (sometimes with interest) is a common method of paying your ex the value of their share of the business.
- Take on an investor. You can raise cash by selling a minority stake in the company to employees or securing an investor or group of investors that want to buy into your company.
- Sell the business. Unfortunately in some cases the only answer is to sell the business and divide the sales price with your former spouse. This is certainly not the optimal way to go but many a successful business person has risen from ashes to succeed again.
Getting a Fair Business Valuation
The key element in any divorce involving a privately held company is the valuation to determine the actual worth of the business. In most cases, each spouse will be represented by their own expert to conduct the valuation and to challenge each other’s findings. These valuations can be very subjective and are often contested in court.
“How the valuator chooses discounts and other criteria can have a significant impact on the value each appraiser ultimately ends up with,” says Ken Bell, a partner with D’Amore Tatman Group, a Cleveland-based certified public accountant and business advisory group. “The best advice we can give a business owner is to hire a good attorney and a qualified, experienced valuation expert early in the process.”
When small business owners are faced with a divorce and need to hire a business valuation expert, Bell recommends keeping the following items in mind:
Hire a qualified appraiser – either Certified Valuation Analyst (CVA) or Accredited Business Valuator (ABV) – who handles divorce valuations for small business.
When valuing a closely held business owners should be aware of “double dipping.” This occurs when excess compensation is normalized (usually lowers the compensation and increases the value of the business) but the excess compensation is not normalized to value alimony payments. As a result, the alimony is based on higher compensation and in essence “double dipping” or overvaluing what the spouse will get.
The area of separate and marital property can be a very difficult one to decipher during the valuation process. First, the valuator needs to consult with the client’s attorney for classification of marital or separate property, and to ensure that the valuation will reflect the appropriate state laws and court precedents.
Community property is based on the assumption that all property that is part of the marital estate is owned jointly by spouses and shared equally. However, some states have started dividing property in a fair and equitable manner rather than splitting it equally. For example, in some states if the spouse was deemed at fault for the divorce they could be awarded less than 50 percent.
Make sure discounts are reasonable because they can have a significant impact on the valuation. This can be subjective so make sure the valuator understands your business and the market for the business they are valuing.
Make sure the valuation date is specific and includes the date of marriage, date of gift/inheritances, date of separation, date of filing, date of trial, etc.
Accumulation of marital property typically begins on the date of marriage and there may be instances when the appraiser will be asked to value a business at this date. This typically occurs when one of the spouses owned a business prior to marriage.
Have confidentiality agreements for information produced during the valuation and expert witnesses available to testify if necessary.
Jeff Fenner is a Cleveland-based writer and frequent Snow Magazine contributor.