When entrepreneurs divorce, the businesses they have created and grown create layers of complexity that other divorces will likely not have. In this article, we will address primary concerns business owners have and how you can protect your business in a divorce. Here’s what we will cover:
- Characterizing and valuing business assets in a divorce
- Dividing business assets in a divorce
- Protecting a business in a divorce
- FAQS on business ownership and divorce
Characterizing business assets in a divorce
When it comes to protecting your business in a divorce in the state of California, which is a community property state, the general rule of thumb is that each spouse is entitled, with exceptions, to half of whatever assets and liabilities they acquired after their marriage and before their separation. Generally and without some exceptions, any assets or liabilities acquired before their marriage, received by gift or inheritance, or after their separation will remain with the spouse who acquired them, without the other spouse gaining any equitable interest.
Such seemingly easy lines of demarcation for division of property are often more obscure when a business is involved:
- Some businesses are formed before marriage but then grow significantly during the marriage, either as a result of the managing spouse’s efforts, the market for such a business, or a mix of both;
- Some businesses are inherited from parents after marriage;
- Some businesses are started, owned, and operated by both spouses, either before, during, or after their marriage; and
- Some businesses are wholly owned and operated by one of the spouses, with zero involvement or even interest from the other spouse.
Dividing business assets in a divorce
The core necessity for dividing a business in a divorce is to get an objective business valuation by a third-party evaluator. These evaluators look at every part of the business (liquid and non-liquid, tangible and intangible) in its totality. Businesses have more complex asset and liability catalogs when compared with estates that families manage. Even corporate bank accounts have different rules than accounts for private individuals. Many business assets are in the form of buildings and equipment, where depreciation may factor in. If a business is public, investors and shareholders will also have a stake in the company. Some of their assets are intangible, like intellectual property rights or the efforts of a managing spouse, that can be the basis upon which the business is built.
The business valuators issue an opinion, typically via written findings, about the fair market value of the business, which assists with dividing the community and separate interest(s) of the asset, as applicable. They are also able to generate historical valuations, which will be especially necessary if the business was started before the marriage but saw significant growth or decline during the marriage.
Throughout the valuation process, there must be no attempts to hide assets or in any other way, to alter the value to impact the divorce settlement. These actions are in express violation of the strict requirements of disclosure, good faith and fair dealing, and the fiduciary duties owed between spouses. They also unnecessarily increase the time and drive up the costs of the divorce, as other professionals (e.g., forensic accountants) must be retained to discover and rectify those actions, in addition to costs associated with litigating in court to address such attempts. As with any issues impacting a divorce, it is essential to be honest and transparent in these matters.
All businesses involved in divorces, like the families themselves, are unique. No precise formula can be given to predict how each business will be divided in a divorce. If the divorcing spouses are able to reach a settlement agreement involving division of the assets and debts at issue, inclusive of the business, that does not violate any law or public policy, the presiding judge will likely approve their agreement. If the parties cannot reach such an agreement, likely the judge will make those decisions for them, via court hearings or a trial.
Protecting a business in a divorce
Dividing a business in a divorce can put that business in jeopardy. The non-entrepreneurial spouse may know little to nothing about the business and how to run it, but they may request decision-making power over it even when the managing spouse has had full responsibility over the business before the divorce. If they harbor any feelings of hurt or anger toward their spouse, they may be tempted to use this power wrongfully. They must remember that such actions would not only hurt the business (and, hence, their ex-spouse) and their own undivided interest in the business. However, it could also hurt the employees, clients, and vendors who, to various degrees, depend upon the viability of that business for their own livelihoods.
The best way to protect a business in a divorce is to be proactive. Prenuptial and postnuptial agreements can delineate ahead of time which assets and liabilities are separate property and which are community property and how they will be divided. When crafted with the advice of competent counsel, and in accordance with the applicable laws to make these agreements enforceable, such marital agreements can be used as a tool to eliminate the headache, time, and cost involved with negotiating a settlement in the heat of the divorce process.
In the absence of such an agreement, there are a couple of different courses of action that can be taken to divide and maintain the viability of the business:
- Buy-out. Though an expensive solution, the buy-out option provides the cleanest way to secure the business. Generally, the spouse who wishes to retain the business would need to buy-out the other spouse’s 50% interest of the community property value as agreed upon by the parties, or court order.
- Co-ownership. If both spouses are able to cooperate in general, they may be able to arrange and manage a continuance of ownership by both of them. This co-ownership does not need to involve decision-making by the second spouse, but they can continue to receive income from it.
Protecting your business in a divorce involves more than merely ensuring its assets don’t get plundered by the other spouse. The intellectual property mentioned above and any models or “business secrets” used to grow the business must also be protected. Above all, the reputation of the business/brand may be the most important asset. There are several ways to protect these components of a business, often in combination with each other, but they do require the parties to agree to same, or obtain these protections via a court order:
- Non-disclosure agreements (NDA) or a protective order prevent the spouses from divulging any disclosed intellectual property or other secrets of success the business may have;
- Non-competition agreements (NCA) prevent the spouses from starting their own business using the same products and methods of their spouse’s business. Depending on the terms of the agreement, the NCA may have a time or geographical location limit, outside of which a new business may be started; and
- Social media or related confidentiality clauses prevent the spouses from publishing any information (whether true or not) that is expressly designed to tarnish the reputation of their former spouse and/or their company.
Need Help Navigating How To Protect Your Business Assets In A Divorce?
Dividing and protecting a business in a divorce is a complicated process that involves many intricate details. The team approach of family law attorneys, business attorneys, and accountants should be consulted for each step, to ensure that the results are truly fair, in accordance with applicable laws, and based on verifiable data. Our family law attorneys at Hoover Krepelka are well-experienced in managing divorces involving businesses. If you are a business owner facing a divorce, contact us today by filling out the form below, and we will work with you to ensure your business remains viable.
Business & Divorce FAQs:
Q: How can I protect my business from being considered a marital asset during divorce?
A: To protect your business from being considered a community property asset, it’s essential to have an enforceable prenuptial or postnuptial agreement in place, prepared by competent counsel who can address the many strict requirements of these agreements. This legal agreement should clearly define your business as separate property and outline how it will be treated in case of divorce.
Q: What steps should I take to ensure my business remains separate property in the event of a divorce?
A: There is no one method to ensure your business remains separate property and even with meticulous record keeping, separate property claims to a business will still be challenged by the other party. However, spouses managing the business should maintain clear separation between personal and business finances and avoid commingling funds. You should always consult with a family law attorney experienced in business protection in advance of and during divorce.
Q: Can my spouse claim a share of my business if they were not involved in its operations?
A: In California, a spouse may still have a community property claim to a portion of the business’ value, even if the non-managing spouse was not directly involved in its operations and even where the business was started before the marriage. In these scenarios, courts often consider the efforts and income received by the managing spouse, the family’s contributions to the business, among other factors in property division.