What Happens to Your Business in a Divorce?

No one stands at the altar on their wedding day contemplating the likelihood of their future divorce. We all expect that our marriage will be one that stands the test of time. But the unfortunate reality is that about half of the people who marry will at some point get divorced. While divorce is painful for everyone, it can be especially complicated and painful for a business owner. In this article we will address some of the issues involved in divorce for the business owner.

Premarital Agreements Can Make the Business Owner’s Divorce Less Complex

Every state in the U.S. has either statutes or case law that provide for the right to enter a binding premarital agreement. Generally speaking, premarital agreements can contractually define the terms of a divorce should the parties ever split. For someone who owned a business prior to their marriage a premarital agreement can potentially be a lifesaver, as it can limit and even avoid arguments over many potentially sticky issues. Obviously, laws in every jurisdiction vary, so if you find yourself in this position prior to marriage you would be wise to consult with a good family law attorney about the possibility of a premarital agreement. Or, even better, sit down with a mediator who is also trained in family law and together negotiate the terms and conditions under which you will part ways in the unhappy event of divorce.

How Will the Business Be Valued at Divorce?

Even in businesses where both spouses are involved it is often apparent which spouse is more necessary to the future of the business and should continue to run it. In my experience it is rare that spouses fight over control of a business. What spouses frequently do fight over is what value is attributed to the business. Typically, the spouse who will keep the business claims it is worth next to nothing while the non-owning spouse argues that the business is the next Facebook or Microsoft and is worth an astronomical figure. The truth is normally somewhere between.

Typically a business valuation expert will be retained by one of the parties or sometimes, where the parties are in mediation, by both parties jointly by agreement. The valuation expert will evaluate the business, review the financial records, interview key employees, analyze the industry for key trends and ratios, and prepare a report which places a numeric value on the business. Although the process is significantly different the end result is somewhat similar to a real estate appraisal.

In some cases each party retains their own valuation expert to prepare a report. If necessary, both of these experts can appear as an expert witness in the case to testify as to their reasoning and provide support for their valuation number.

Capital Gains Embedded Tax Issues

A commonly overlooked issue in business valuation is the potential capital gains tax that the business owner would incur if the business were sold. For example, let’s say the business was purchased for $100,000 several years ago and then is sold for $900,000. Upon sale a gain of $800,000 would accrue to the seller, which would be taxed under the appropriate capital gains tax rate. If we assume a 15% capital gains tax rate this would equate to a $120,000 tax liability. Often this future tax issue is ignored in the valuation process even though it can significantly reduce the net value to the owner upon sale.

Can Ex-Spouses Co-Own the Business?

Occasionally, the parties in a divorce case will want both spouses to remain owners of the business post-divorce. While this is technically possible, it is usually a very bad idea. Even if the parties are divorcing “as friends,” continuing to work side-by-side into the future is likely to get very awkward when one or both parties begin new relationships. My advice in this situation is usually to instead work on determining a fair value for the business and structuring a reasonable buyout of the non-owning spouse.
If that is just not what the parties wish to do at dissolution, they should by all means come up with a decision making protocol to avoid deadlock when it comes to business decisions and management.

While divorce for business owners is certainly more complicated than most divorces it is possible to resolve the issues fairly to both parties and without the need for extended and hostile litigation. The complexity of the issues creates a situation that is ideal for resolution by mediation. With mediation you can avoid a long drawn out court battle, “dueling” valuation experts and achieve finality with a result that is yours, rather than a result that is imposed upon you by a court.

This is a guest post from board certified Texas family law attorney Scott Morgan. Scott has practiced family law since 1994 and is the founder of the Morgan Law Firm which has offices in Houston, Austin and its newest office in Sugar Land. You can read more about Scott Morgan on his divorce blog.