Divorce is rarely simple. When two people’s lives are intertwined—physically, emotionally, and legally—separating the individual strands can be a task akin to untying the Gordian knot. The longer a couple has been together and the more they share, the more difficult this task becomes. It can be even more difficult if the divorcing couple co-owns a business or one spouse owns a business.
Marital assets—including a business—are divided between the parties as part of the divorce process. But determining who the business belongs to and ascertaining its fair market value can be very complex. It could entail each party hiring a valuation expert to perform a thorough accounting of the business’s history. Moreover, the division of a business interest can affect more than just the divorcing couple. If the business has other owners, the divorce can also impact them.
How Assets Are Valued in a Divorce
In most states, equitable distribution is the method used to divide assets during a divorce. In the simplest terms, a court classifies assets as either marital (owned by both spouses) or separate (owned by one spouse). The court then assigns the marital assets a value and distributes them equitably, but not always equally, between the spouses.
For some assets, determining the value for purposes of equitable distribution may be relatively straightforward. Valuing a joint checking account, for example, is as easy as looking at the account balance at the time of separation. Valuing the marital residence is relatively easy, too. You can look at the value of the property used to calculate your property taxes, or alternately, hire an assessor to gauge the property’s value.
But some assets are more difficult to value, such as investments, collectibles, art, and business interests. In fact, a business can be one of the most challenging assets to value. Before getting to valuation, though, it is necessary to determine who actually owns the business.
Is the Business Marital Property or Separate Property?
There is no bright line rule for determining ownership of a business in a marriage. It instead involves the consideration of many factors, including but not limited to where the business was formed, when it was formed (before or after the marriage), who worked in the business, and how resources were allocated to and from the business. If the business was acquired during the marriage, with each spouse contributing time or money to it, the business will most likely be considered marital property and its value divided equally between the couple. If the business was acquired or formed by one of the spouses prior to marriage—or if one of the spouses acquired or formed the business with their separate funds during the marriage—this might mean that it is separate property.
But it might not. A business can start out as separate property and become marital property based on several factors, including the following:
- Marital assets were invested in the business
- The business borrowed money from jointly-owned accounts
- Both spouses worked in (on contributed in any material way) to the business
As anyone who has been married knows, it is hard to keep things separate from your spouse. This is especially true with a business that contributes to the family’s income and necessarily affects the nonowner spouse.
Furthermore, even if one of the spouses already owned the business before marriage and managed to keep it separate—which, again, can be very challenging—an increase in the value of the business could be considered a marital asset subject to equitable distribution.
And finally, consideration must be given to the state where you live. Most states are equitable distribution states that assign an equitable, but not necessarily a fifty-fifty split, to marital property. A minority of states, though, are community property states. In Arizona, California, Idaho, Louisiana, Nevada, Mexico, Texas, Washington, and Wisconsin (plus Alaska, when the couple consents to it), all marital property is treated as equally owned by both spouses.
In other words, if you live in a community property state and own a business that was started during the marriage, your ex-spouse could automatically receive 50 percent ownership of your business interest in the divorce, especially if no prior planning took place.
Valuing and Dividing a Business Interest
Now that you have a basic understanding of how assets are viewed in a divorce, attention can be given to how a business interest is valued and, ultimately, divided.
To illustrate, assume that a business is determined to be a marital asset. The next step is to figure out how much the business is worth. A few different approaches could be used:
- Subtracting total business liabilities from total business assets
- Looking at the sale price of similar businesses that have been sold in the area
- Evaluating cash flow, profits, and rate of return over time
Regardless of the valuation method that is applied, it is common for each spouse to hire their own expert to perform an appraisal. This may not be necessary for a small business interest with a value that the parties agree on. But for a larger and more profitable business, experts such as a certified business appraiser or a certified public accountant are often hired.
You may already have guessed that this road of dueling experts can lead to differing opinions. Not only that, but the owner spouse is incentivized to arrive at a lower valuation, while the nonowner spouse is motivated to get a higher value. A judge may ultimately decide whose valuation is more accurate. Just remember, the longer this process drags on, the more the spouses will pay in attorney and expert fees. For that reason, it is in the interest of both parties to sign off on a value for the business sooner rather than later.
Other Sources of Guidance
The marriage and property laws in your state go a long way towards resolving the distribution of marital assets. But certain types of contracts can also play a role. These include agreements between you and your spouse such as prenuptial and postnuptial agreements, which identify each spouse’s property rights in a divorce. A prenuptial agreement, for instance, might specify that, in the event of a divorce, the business remains one spouse’s property. Such an agreement would override a divorce decree.
The operating agreement is another document that may bear on your divorce—and the fate of your business interest. An operating agreement lays out rules about the relationship of members of a limited liability company (LLC). Some LLC operating agreements contain a divorce clause specifying the actions members can take to prevent the spouse of a divorcing owner from obtaining an interest in the business.
Whether you live in a community property state or an equitable distribution state, the court could award a share of the business to each spouse. Your divorce could trigger the operating agreement’s divorce clause and allow the other LLC members to buy out your ownership interest, thus preventing your spouse from becoming an owner. The exact procedure for a buyout can be explained in greater detail in a buy-sell agreement.
Talk To a Lawyer
Nothing can complicate a divorce quite like a business. There may be questions about who owns the business. Or, the business may have been co-owned and co-operated as a couple. In addition to the actual value of the company, the business can raise divorce issues related to income, tax debts, and spousal support.
Monetary issues aside, divorce can negatively impact business operations as you are forced to take time off to deal with legal issues. The longer the divorce process takes, the more expensive it becomes and the more your business may suffer. For those who put years into the business and depend on it as a primary source of income, this may not be a fight you can afford to lose. You may be determined to keep the business at the cost of giving up other marital assets in return.
We would be happy to help guide your planning.