According to the Small Business Administration, 90% of U.S. businesses are family owned. They play a vital role in their communities and the entire economy. Owning a family-run business has many advantages, like getting to work with the most important people in your life, convenience, flexibility, and lower employment costs. Still, mixing business and personal life can be traumatic and expensive, when one or both spouses want out of the marriage. Many business owners do not properly plan for this type of potentially destructive situation.
August marks the one-year anniversary of No-Fault divorce becoming legal in all 50 states. Starting with California’s groundbreaking no fault divorce law 42 years ago, the adoption of no-fault divorce laws across the country has the potential to simplify and reduce the cost of divorce for many people because either spouse can initiate the divorce and there’s no need to assign blame. However, a divorce can still be incredibly pricey for small business owners – and if sufficient care is not taken, it can ruin the company. If you’re a small business owner, you need to take extra steps to ensure your business can survive a divorce among the principals.
Consider that for most family business owners, the business is probably the most valuable, and the most illiquid asset in the marriage, meaning that it cannot be easily sold or exchanged for cash without a substantial loss in value. To make matters more complicated, community property states, such as California, require that all property of the marital “community” be divided equally, including family owned businesses.
When dealing with a divorce-affected business, the route of least resistance is when a Prenuptial Agreement is already in place. Parties will have already decided what property will be considered separate property (owned by one spouse), what property will be marital property (shared ownership), and how the martial property will be dealt with in the event of a break-up.
However, many small business owners are focused on making their business successful on a day to day basis, and put off thinking about a plan in case the marriage fails. Without a Prenuptial Agreement or another clearly defined exit strategy crafted by a lawyer, the life of the business can hang on the line. For most business owners, splitting the business in half is like “cutting the baby in half” — in order to truly split the assets, the business either has to close its doors completely or sell the entire business to a third party and split the proceeds — a nightmare situation for a business owner who has spent a lifetime building a company. Another less-than-ideal option is to continue working with your spouse as a business partner, which may not bode well given that things didn’t work out as marital partners.
So what can business owners do to preserve a family-owned business when the marriage ends? The good news is that once the preventative and protective avenues have been closed, there are still a number of routes at your disposal. Consider these tips to get through a divorce, without breaking up the business.
1. Be rational and consider compromise.
A personal break-up does not have to signal the end of your business. First and foremost, both involved parties need to separate discussions concerning the business from any private and personal property squabbles. Protecting the business — its worth and integrity — should be a top priority. What this means is removing emotional involvement from the situation (as much as possible) and trying to think and act objectively as possible.
2. Hire an independent business appraiser.
As part of the divorce proceedings, one of the first steps is to have you business valued. Remember that it is always worthwhile to hire an independent professional. When you and your partner are not joint owners, agreeing on a value can prove problematic. With the owning partner looking for a low value, and the non-owning partner looking for a high one, the valuation method that is used, whether asset-based, income-based, or market-comparables-based, as well as the discounts taken, can all be a matter of dispute.
3. Know the local law.
Knowing local law is critical. While most jurisdictions will include the value of “enterprise goodwill” in a business appraisal, many will exclude “personal goodwill.” Some states will not even distinguish between the two types of “goodwill” and allow for valuation of both. To maximize your results, your attorney and your business appraiser should agree on strategy and valuation methods, while keeping an eye on current cases, evidentiary rules and statutes that could affect the outcome.
4. Think about role transition.
If the spouses will continue to work together in the business, the divorce will probably require a change in roles. For example, a spouse may no longer work in the enterprise, as a partner, executive or board member. In that case, the replacement of the spouse’s skills and working out a transition of the business role may be part of the divorce process. If the spouse has a new role, it’s essential to clearly define (and potentially limit) the spouse’s decision making powers in the company, in order to prevent future disputes. Whatever you do, be realistic about the ability to work together in the business. Often one spouse will need to step away for the business to continue operating.
5. Be transparent.
Don’t make any big changes to your business during the divorce proceedings, like changing the business model to decrease revenue or appointing a new love interest to your board of directors. You’re more likely to send a big red flag in court, and you could jeopardize your business (and face steep fines if you’re hiding assets). It’s better to be honest and use legal strategies to reach a solution.
For more divorce legal information, please visit the Rocket Lawyer Divorce Legal Center.
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