A divorce can wreck more than just a life plan. It can easily destroy a small business. Whether the court awards part ownership to your ex-spouse, you’re forced to sell the business to split the value, or you have to slowly buy back your equity from your ex, there are several scenarios that can stress both the business owner and the business to the point of failure.
Part of this depends on the state you live in. Seven states are equal distribution states. If you live in any of the following, then all community property is split 50/50 between spouses:
- Arizona
- California
- Idaho
- Louisiana
- Nevada
- New Mexico
- Texas
- Washington
- Wisconsin
All other states are equitable distribution states, meaning the courts divide assets on what they think is fair. This generally means that the spouse who earned it, owns it. However, a court will not leave a stay-at-home parent destitute because they chose to raise the couple’s children.
For small business owners, this means your company is on the dividing table, even in equitable distribution states. The results of which could mean selling the company, scrambling for funds to buy out your ex, or finding yourself in business with an ex-spouse.
Protecting Your Business Before Marriage
If you are not yet married, you have the most options for protecting your business. While planning for divorce with someone you expect to spend your life with doesn’t make sense at first, switch to a business perspective. You forecast expenses. You create contingency plans. Preparing plans to protect your business in a divorce is just a contingency plan, one that you hopefully won’t use.
Prenups
A prenuptial agreement is the best way to protect your business from an unexpected end to a forthcoming marriage. Work with a divorce attorney to draft in language that will hold up in court.
When you have a business before you get married, it is considered separate property. Once you get married, even in equitable distribution states, the company growth after marriage can become community property. You increase your chances of this happening if your spouse helps out in ideas or unpaid work. If you use personal money or money from a joint bank account to help fund your business, it quickly becomes community property.
Your prenup should detail exactly what would happen in the event of a divorce. Have a family law attorney look it over to make sure that it will hold up in court. Your business lawyer may not have the necessary family law experience for this.
Incorporating
Creating a legal entity for your business helps separate it from your person. This doesn’t prevent a divorce court from dividing it, but it can help. Particularly if you start paying yourself a salary that is within the normal market range.
Living Trust
Trusts are separate from people. However, they can own property and open bank accounts. This includes businesses. One of the best ways to protect your business is to transfer ownership to a living trust you create.
While you may control the trust, you don’t technically own your business once you transfer it. The trust owns your business. Courts can divide income from the trust because it becomes yours. They can account for that income in alimony calculations, but they can’t force the trust to divide its assets.
Creating a living trust and transferring ownership before you get married means that there is no confusion about separate or community property.
Create a Buy/Sell Agreement
Business involving partners create buy/sell agreements to clearly define the transition of business ownership. You can create one of these where the trigger for initiating the agreement is a divorce.
The buy/sell will outline exactly what your spouse will own in a divorce. It will also state terms for how and when you will buy out their shares. You will need the help of a business attorney on this one.
When the Relationship Hits Rough Waters
Once a petition for divorce is filed with the courts, your actions become extremely limited. You cannot frivolously spend money. You can’t move around assets or transfer ownership.
If you’ve hit a rough patch and you don’t think the two of you will be able to overcome it together, it’s time to prepare contingency plans. Hopefully, you won’t need them. But they’re there just in case.
Make Sure You’re Paying Yourself Market Rates
Many business owners choose to make themselves poor on paper through creative accounting. They may own a Ferrari, but the IRS thinks their income is well below average. This doesn’t do anything for you in a divorce situation.
If you pay yourself next to nothing, then your spouse’s divorce attorney could argue that the money got reinvested into your company and instead belongs to your family. Almost like the family was reinvesting the money into the company.
How and what you pay yourself is between you, your accountant, and your financial planner. But it is something to take into consideration if divorce may be looming ahead.
Separate Your Spouse from the Business
If your spouse is working for your business, you have the option of firing them. Granted, this is a guaranteed way to create the mother of all arguments. Getting fired is bad enough. Fired by your spouse adds a whole new level of drama.
If your spouse doesn’t directly work for your business but still contributes in ideas or helps you manage your marketing, then scale back the work they help with. You often see people call this sweat equity. Those were just two examples. There are many, many ways your spouse can help with your business in an unofficial capacity.
The less involved your spouse is in your business if a divorce comes, the better.
Create a Post-nuptial Agreement
A post-nup is a prenup created after the wedding. It does all the same things as a prenuptial agreement. You can detail exactly how you will split up assets and debts, including your business.
You can do nearly anything with this document from how to value your business to the terms of how your spouse will get paid out for their share, if at all. Make sure both you and your spouse have separate attorneys to review the document. Without that precaution, it may be thrown out in court.
Once the Divorce Is Initiated
Your options are most limited in this scenario. Since you can’t spend money on much anything but reasonable living expenses, putting your business in a defensible position gets tricky.
Trade Assets
Your business is your money-making machine. Trading other assets to keep your business intact is worth it. Whether that is equity in your home, cash, stocks, or even cars, you may want to consider your options for negotiation.
Make the Case That You Need Your Business to Pay Alimony/Child Support
If your divorce lawyer can successfully make that case that it’s in both spouse’s best interest to keep the business intact so that you can earn money for child support or alimony, this can work. It’s not a guarantee, but it doesn’t hurt to try.
Advantageous Business Valuation
There are several ways to determine a business’ value. Some of these make the business look wealthier than others. Talk with your lawyer and accountant to see which type of business valuation may work in your favor.
What If Your Soon-to-be-ex Owns the Business?
You can reverse most of these strategies if it’s your spouse’s business. Start by documenting everything you do in the business, whether you work in it officially or with sweat equity. The more documentation you have that ties you to the business, the stronger your claim for community property.
Make sure you get copies of any business ties to banks, attorneys, and accountants. Money moves through businesses in increasingly complicated and clever ways. If you have the names of all the establishments your spouse’s business works with, your divorce lawyer can get the financial information.
If you are likely to receive alimony or need money for child support, keep in mind that it may be in your best interest for the business to remain intact. Divorce is not about revenge. It’s about money. If you will own part of the business coming out of the divorce, it may be best to structure a buyout agreement with your ex-spouse and any other owners. That way they can still run the company, and you get cash for your shares over time.
In any course of action you take, make sure to consult with an attorney who has experience with divorces involving businesses. They can create the best course of action for you.
