Dividing Business During Divorce
Businesses are regularly attacked in divorce. The way the owner has managed the operation of the business, including the capitalization and debt structure, can alter the value and, in some instances, even the character of part or all of that entity.
In assessing the fate of a business during a divorce, the attorneys and the court will have to identify the character of the business (is it separate or community property).
If one spouse started a corporation before marriage, that company is his or her separate property, even though the business may have grown and increased in value throughout the marriage. If the business was started during the marriage, it will be considered, at first, to be a community asset. But if it was capitalized by one of the spouse’s separate property, that asset might quickly turn to a separate property item or perhaps a mixed character asset (part community and part separate).
Even if a business is the separate property of one of the spouses, the income from that business, including distributions of profits and dividends, belongs to the community and is subject to division. As distributions are taken and then put back into the business, the assets inside the entity start to become commingled, and the community estate may begin to develop an ownership interest.
If an entity, such as a corporation, is created, it stands alone. It can own assets, bank accounts, owe money and conduct business, all within the limits of its corporate shell. The parties to a divorce may own shares of stock in the company, but the entity still owns and operates inside of itself.
That corporate shell can be cracked though. It often happens, particularly with closely held businesses, that the managing spouse uses the business like his or her personal checkbook. The cars are purchased through the business, along with the family boat. Vacations, meals, clothes, or any number of other items get paid for out of the business. The more corporate formalities that are ignored by the business owner, the more likely the corporate shield will be ignored by the court.
Every case is different, but in general, courts avoid keeping people in business together after they divorce. That really leaves three choices: One or the other spouse gets the business, or the business gets sold.
The ultimate question in valuating a business is “what will someone pay for it?” If it’s a closely held business (for instance, owned entirely by the couple), there may be a discount on the value due to the lack of a continuity of management after the business is sold. Is one spouse’s personal goodwill a large factor in the success of the business? If so, it will be worth less if they are no longer around to run it. How long would it take to sell? The list of factors goes on. Professional forensic valuators spend years practicing their craft to give courts and attorneys the most accurate valuation possible.
A business owner may testify to the value of his or her own company. But a strong valuation done by a forensic expert will also be considered, along with any incentive the court perceives the testifying owner may have to underestimate the value of the entity.
A separate property corporation may be sold and the money from the sale used to buy or start another business. So long as the money from the sale can be traced, with specificity, into the new business, that new entity can be preserved as the original party’s separate property.
If the company is publicly traded, the division generally becomes far less complicated. Publicly traded stock is valued on the exchange and ownership of that stock doesn’t require any interaction between former spouses. The court may simply divide the stock.
Professional practices – law, medical, dental – may be valued and the value may be considered in the division of the community estate. But a non-professional can’t own a part of a professional practice. For instance, a medical practice can’t be owned, in part or in whole, by someone who is not a doctor.
Partnership agreements may limit the transferability of an interest in a company to a spouse. They can also fix the value of an interest in the entity and allow for the business to be bought by the other partners or shareholders in the event of divorce. Whether a court will allow such agreements to operate to the detriment of an unknowing spouse will depend, to a great degree, on what line of cases the court tends to follow.
It takes decades of experience to understand and master all of the ways a business can be divided in a divorce. The expert team at Orsinger, Nelson, Downing & Anderson can help find the most advantageous solution for you.