Don’t Let Divorce Slow Down Business

source: https://www.thebalance.com/a-guide-to-the-most-common-financial-issues-of-divorce-1289262

 

In my last post, I discussed how a business becomes marital property and how owners can minimize damage to their business during a divorce. In this post, I will address equitable distribution when the business owners did not engage in a prenuptial agreement, and their business’s operating agreement does not address what happens in the event of divorce. If you need a refresher on equitable distribution, prenuptial agreements, or operating agreements, click here. This post focuses specifically on a situation where divorcing spouses are the only business owners. Focusing on this scenario, I will discuss the ex-spouses’ options when they have to divide their business.

 

To dissolve or not to dissolve?

source: http://sepahilaw.net/dissolve-business-california/

Divorcing spouses should first decide whether their business should continue. They should at least consider these 3 options: dissolving the business or selling it, one owner buying out the other, or continuing to work together.

 

When considering whether to dissolve the business, you should look to the projections of the business over the next few years. If you dissolve, will you be missing out on a huge opportunity for increase? On the other hand, is the business going downwards in the next few years? Is the business starting to fail now? Will the business be able to thrive if you or your spouse leaves the company, or are one of you replaceable? The best way to make sure each party is truly, fairly compensated is to dissolve or sell the business.[i] However, it is not unusual for divorcing business partners to buy one party out and keep the business going, so do not feel obligated to dissolve if one or both of you want to keep it.[ii]

 

Keeping the business going

Equitable distribution occurs only after a divorce decree is entered.[iii] During the time between your divorce complaint is filed and equitable distribution begins, you and your former spouse can determine whether you can or should continue working together. This issue is something that you and your spouse will likely want to agree on; if you do not, the court can decide what happens with your business if there is no prior agreement in place. There are several issues that you and your spouse should consider when making this decision.

source: https://www.dreamstime.com/close-up-two-angry-young-business-partner-shouting-each-other-office-two-angry-business-partners-shouting-each-other-image126272866

First, you should seriously consider whether it is practical and constructive for you to work together. Divorces can get contentious, and they typically begin because spouses are not getting along. Can you both put aside your differences to work together now and in the future? Bad business relationships can lead to bad business. Think about where you will be a year from now, and if you cringe at the thought of seeing your ex-spouse at work every day, perhaps you should choose one person to continue the business. Another alternative is to allow each person to have an ownership interest in the business, but only one person operating it.[iv]

 

Who keeps the business?

source: https://lsrfirm.com/how-to-better-protect-you-and-your-interests-when-dissolving-a-business/

Typically, business partners who get divorced have one spouse buy the other out of the business. The biggest question is, who gets to keep the business?  Some issues to consider are who has the skill required to conduct the services or create the product the business provides, who has the business savvy to keep the business going, and which partner provides certain responsibilities that may be replaceable with a new employee. You should also consider these issues when each person keeps an ownership interest in the company, but only one person maintains the operation.

First, consider what your business does. Some businesses require a particular license to provide a service. For example, lawyers, electricians, doctors, and contractors require a state license to practice their profession. If one of the business partners has that license and conducts the particular service, perhaps it is best for that person to keep the business to avoid halting production to hire someone who has that license. On the other hand, some services can be performed by anyone, or it is possible to hire someone else who is able to do the same work for an affordable salary. If one person performs responsibilities that can be done by hiring a new bookkeeper, or the other person who runs the operation is able to take on that responsibility, perhaps that person should be bought out.

 

How do I buy out my former spouse? 

You might not realize how much your business is worth until you have to give half its value to another. Just because your business does not have a lot of cash on hand does not mean that it has a low value. You will have to equitably split that value with the person who is exiting the business.

After you decide that one party should be bought out, you and your spouse will have to hire a competent, third party to value the business. The valuation will include all of your assets, and should also include the goodwill of the business. Goodwill is considered personal to the professional and is typically not included in equitable distribution when only one spouse owns the business. However, when both spouses provide the goodwill to the business, it is appropriate to include it in the equitable distribution.[v]

If there is not enough cash to buy out the exiting spouse, there are other marital assets that the spouse retaining the business can offer. The remaining business owner can offer their house, or an IRA account or 401K account (while considering potential tax implications).[vi] Any asset can be exchanged in lieu of a buyout, as long as they are of equitable value. The remaining owner can also raise business capital through a bank loan or a Small Business Administration loan to buy out their former spouse.[vii]

Regardless of the route you and your ex-spouse pursue, you should consult a lawyer to determine the best course of action.

 

Sources:

[i] https://www.rosen.com/business/business-articles/dividing-business/

[ii] https://www.cobizmag.com/Companies/The-dos-and-donts-of-divorcing-your-business-partner/

[iii] In re Estate of Bullotta, 838 A.2d 594 (Pa. 2003).

[iv] https://www.rosen.com/business/business-articles/dividing-business/

[v] Butler v. Butler, 663 A.2d 148 (Pa. 1995).

[vi] https://www.rosen.com/business/business-articles/dividing-business/

[vii] https://mvolaw.com/2012/04/financing-the-buy-out-of-a-business-interest-in-a-divorce/

Photo sources:

https://www.thebalance.com/a-guide-to-the-most-common-financial-issues-of-divorce-1289262

http://sepahilaw.net/dissolve-business-california/

https://www.dreamstime.com/close-up-two-angry-young-business-partner-shouting-each-other-office-two-angry-business-partners-shouting-each-other-image12627286

https://lsrfirm.com/how-to-better-protect-you-and-your-interests-when-dissolving-a-business

 

Preparing your Business for Divorce

By now, this fact is almost common knowledge, but it is worth repeating- roughly 50% of marriages end in divorce. Yet, many people get married without preparing for that possibility. For business owners, failing to prepare your business for unexpected life events can cause major issues down the line. Below is information on how marital assets are split in Pennsylvania, and how business owners can protect their businesses ahead of time through marital and operating agreements.

What is marital property and equitable distribution?

Like most states, when couples get divorced in Pennsylvania, their assets are split equitably. “Equitable distribution” means that each party gets a percentage of the marital property that the court considers to be fair. So, in situations where one spouse has a job that produces income, and the other spouse provides domestic work (like cooking, cleaning, and childcare) without an income, the spouse who provides domestic work is entitled to part of the other spouse’s income upon divorce. This describes a partnership theory of marriage, where both spouses contribute valuable work to the marriage, whether or not they produce an income.

Anything obtained during marriage until the date of divorce is marital property, except for a few specific situations. If you started a business during your marriage, the business itself is considered “marital property,” meaning that your interest in the business belongs to your marriage and is subject to equitable distribution.

Even if you started your business before you were married, your actions after getting married can make the business marital property. Actions like putting your business capital in a joint bank account or acquiring a loan with your spouse’s name on it can entitle your soon-to-be former spouse to part of your business’s assets. Additionally, as I explained before, any income you earn through your business during the marriage is marital property.

Your business is probably the largest asset of your marital property, and also probably the most difficult to turn into cash to be divided. Issues may arise for your business when assets are divided equitably upon divorce. Some of these issues can be avoided by planning ahead.

 

Planning your marriage around your assets

A prenuptial agreement is a binding contract that marrying couples enter into before they get married. The agreement addresses each spouse’s property rights if they were to get divorced. Even though about half of American marriages end in divorce, only 5% of married couples have a prenuptial agreement. This low percentage might be because people do not believe that they will ever get divorced, or even if they do, their partner will not take from their personal property. Even though people hope their marriage will last forever, it is best to plan ahead in case that doesn’t happen.

Your prenuptial agreement can include provisions that limit your spouse’s entitlement to your individual business ventures during the marriage. You must fully and fairly disclose your financial position to your spouse before entering into the agreement for it to be valid. If you misrepresent your finances in a material way, your spouse can challenge the enforcement of the agreement. If your spouse is successful, he or she may take an equitable share of your business and other property. If you got married without a prenuptial agreement, you and your spouse can enter into a postnuptial agreement after getting married to achieve the same goal.

 

Planning your business around a potential divorce

You can also plan your business anticipating major life events, including a potential divorce. The best practice is to utilize both marital and operating agreements to protect your business. As I have mentioned, your business is probably your most valuable marital asset, and the hardest to turn into cash. If you do not have enough personal cash on hand or the ability to take out a loan to pay your former spouse their share, it can affect your business operations.

 

Partnership/ operating agreement

Your operating agreement, regardless of the business entity form, can affect your property distribution. Courts often find it difficult to determine the value of the business when dividing it for divorcing couples. In Pennsylvania, the court usually values the business for its marital value, rather than its fair market value.

In a 1990 Pennsylvania Supreme Court case, McCabe v. McCabe, the Court stated that lower courts need to view a partnership agreement as “the preeminent factor in valuing a partner’s rights” in equitable distribution. In this case, the Husband’s partnership agreement (between Husband and his law firm) contained provisions preventing a partner from ending the firm and selling its assets. Partners were also limited in receiving their share of firm profits. Considering that the husband was unable to receive the full value of his partnership interest, the court reduced his partnership interest to what he would be able to receive to distribute to his ex-wife. This decision reduced the husband’s interest upon divorce from $286,000 to $18,900 for equitable distribution. According to this decision, an operating agreement that limits a partner’s right to liquidate the partnership can make a huge difference in the amount valued at divorce. If your business’s operating agreement does not limit a partner or member’s ability to liquidate the business, the court may force you to sell your business property in order to pay out an ex-spouse, which will seriously impact business operations.

Consult a lawyer

You should always consult a lawyer before entering into an agreement to ensure that it is enforceable and executed properly.

Sources

Divorce Image- https://www.moneycrashers.com/filing-taxes-after-divorce-tax-implications/

equitable distribution image- https://burrowsatlaw.com/2018/06/dividing-marital-property/

Prenuptial agreement image- https://www.weinbergerlawgroup.com/relationship-agreements/prenuptial/

Partnership Agreement Image- https://raichattorneys.com/important-nevada-llc-operating-agreement-clauses

Erin D. Hollis, Divorce and the Owner of the Closely Held Business,38- Feb PALAW 42.

Buckl v. Buckl, 542 A.2d 65 (Pa. Super. 1988).

23 Pa.C.S.A. §3501.

Berry v. Berry, 898 A.2d 1100 (Pa. Super. 2006).

Steven L. Fritsch, Prenuptial Agreement Statistics. Dec 7, 2018. https://www.oceansidedivorcelawfirm.com/prenup/prenuptial-agreement-statistics/

Porreco v. Porreco, 811 A.2d 566 (Pa. 2002).

McCabe v. McCabe, 575 A.2d 87 (Pa. 1990).