Dividing a Business in Divorce

Divorce for Business Owners

When a couple files for divorce and own a business, it creates unique issues that must be addressed in the divorce process. This article provides an overview of some of many of those issues.

Businesses Can Be Community Property

Businesses are no different than any other asset when it comes to application of the community property rules in Texas. You can learn more about community property and the general rules for property division here.

There is a presumption that every asset a couple owns is community property and community property is subject to divorce. This means that unless you can show the business is separate property, it is an asset subject to division in the divorce.

One unique issues that arises is with regard to reimbursement claims.

If one spouse has a separate property business, then the other spouse may have a reimbursement claim for time, toil, and effort that the owner spouse put into growing the value of the business during marriage. That reimbursement claim could impact the property division even though the business itself will not be divided in the divorce.

Ways To Divide A Business In Divorce

There are several different options when it comes to dividing a business in divorce. Remember – this only applies to a community property business. Separate property is not subject to division during a divorce.

The first and usually simplest option is a buyout. This means that one spouse purchases the other spouse’s interest in the business as part of the divorce. A buyout is usually accomplished by awarding the entire business to one spouse. The other spouse then receives additional property outside of the business to offset the value of his or her interest in the business.

Alternatively, the business owning spouse may make cash payments to the other spouse to buy out his or her interest. In this scenario, it is important for the other spouse to obtain some type of security interest to protect those payments.

The second option is to sell the business. This requires more time and effort and risks destroying some value in the business if it is sold as a distressed asset. This option requires that the parties exercise caution in how they conduct the sale to avoid a loss in value.

This option also requires that the spouses come to an agreement or seek a court order on how to value the business for the sale. It may also require agreement or court order on the process for conducting the sale. If the court is involved in ordering the valuation or sale process, then it is important that the parties exercise caution. Court orders are public records that could affect the amount received in the sale if the purchaser gleans anything of value from the order.

A third option is to divide the spouses’ interests in the business but allow them to continue as co-owners of the business. This option requires that the spouses be capable and willing to continue their business relationship after the divorce.

Instead of awarding the business entirely to one spouse, we let each spouse keep their interest in the business but partition their interests into each of their own separate property post divorce. In this scenario, it is important that the spouses take steps to protect themselves by drafting buy-sell agreements or other documents to govern their relationship as co-owners moving forward.

Issues For The Non-Owner Spouse

When one spouse is the day to day owner/operator of the business, it creates unique issues for the spouse not involved in running the business.

The non-owner spouse likely has limited knowledge of the business’s operations and assets. This can create a situation where it is easy for the owner spouse to hide assets in the business.

This also creates problems with regard to valuation of the business.

Sometimes the non-owner spouse believes the business to be worth substantially more than it actually is worth. Alternatively, the owner spouse may use the other spouse’s limited knowledge to argue that the business is worth less than it actually is worth.

It is common for business owners to run personal expense through their businesses for tax reasons. This can have a significant impact on the value of the business if not properly identified and accounted for in any valuation.

Issues For Business Owner Spouses DURING Divorce

There are unique issues for spouses that arise during the divorce when both spouses are involved in running the business as well.

Ideally, the spouses can cooperate to continue running the business during the divorce. Sometimes it is difficult to separate the emotions of the divorce from the practical aspects of needing to run the business.

This can create problems with employees, day to day operations, and in extreme cases it can damage the value of the business. In these situations, it may be necessary to appoint a receiver to take over operation of the business on a day to day basis.

If the spouses cannot reach an agreement on running the business during the divorce, then they may need the court to issue temporary orders on who will run the business while the divorce is pending.

Issues For Business Owner Spouses AFTER Divorce

What if one of the spouses is leaving the business as a result of the divorce but has relied on a salary from the business? This can create a financial burden on the departing spouse that must be addressed in the divorce.

What if both spouses are key employees in operating the business but one is leaving the business as a result of the divorce? How does that impact the value of the business as a going concern? Will that departing spouse be allowed to compete with the business after divorce?

As you can see from the discussion above, divorce involving a business can quickly add another layer of complication to the divorce process.

If you would like to schedule a consultation to discuss your divorce case, then please send me an e-mail or click here to schedule a consultation online.

Bryan Willis
Dividing a Business in Divorce

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Dividing a business in divorce presents unique issues and requires careful evaluation of the business to ensure that property is divided appropriately under the just and right standard.

The principles discussed in this article apply regardless of whether the business is operated as a sole proprietorship, corporation, partnership, or limited liability company.

Characterizing a Business Interest

Texas is a community property state and only community property is subject to division during divorce.

The first step is determining whether business interest is subject to division during a divorce is characterizing the interest as either community property or separate property.

Community property is all property owned by the spouses that is not separate property.

Separate property is property owned by a spouse prior to marriage or acquired by the spouse through gift or inheritance.

Texas operates under the Inception of Title Doctrine which means that property, including a business interest, is characterized as community or separate property at the time it is acquired.

This means that if the business interest was acquired by one spouse prior to marriage or inherited through probate, then it is separate property.

This also means that if the business interest was acquired during marriage or if a spouse started a business during marriage, then the business is community property and subject to division in the divorce.

Just and Right Standard

Texas law provides that during a divorce, a court shall:

…order a division of the estate of the parties in a manner that the court deems just and right, having due regard for the rights of each party and any children of the marriage.Texas Family Code Section 7.001

Most people consider “just and right” to start with an equal division of the community property and then adjust the division one way or the other based on a number of factors.

A business interest may or may not be divided between the spouses. In certain circumstances, the interest may have more value to one spouse or the other, or the business may be more valuable if operated under the supervision of one spouse or the other.

A court will consider these factors as well as the entirety of the marital estate when making a decision on dividing or awarding the business interest between the spouses.

Methods of Dividing a Business Interest In Divorce

There are a few options for dividing a business interest during your divorce.

First, if there is sufficient property in the marital estate, the court may simply award one spouse the business and the other spouse offsetting property of equivalent value.

This is a likely outcome if one spouse has operated the business exclusively and the martial estate is sufficient to still allow for a just and right division.

Second, the court may order one spouse to “buy out” the other spouse’s interest in the property. This can be accomplished through an award of offsetting property or it could be accomplished with payments over a period of time.

If payments are made over time, it is imperative for the other spouse to seek sufficient security to protect his or her interest in case the business’s fortunes take a turn for the worse.

Third, the interest could be divided between the spouse’s with both of them continuing on as co-owners of the business. At first this option might seem odd or awkward as the spouses are in the process of terminating their marriage.

Indeed, in the case of a smaller business where the owners are heavily involved in operating the business it might seem even more awkward.

But in some circumstances, it may be that the spouses are perfectly capable of working together in business even if they were unsuccessful in marriage.

The final option is that the court could order the sale of the business then divide the proceeds from the sale between the spouses. This option is the least favored option unless there are requirements to sell the interest (such as in a buy-sell agreement discussed below).

The reason this option is least favored is because of the effect it has on the value of the business. A court ordered sale on a short time frame means that any prospective buyers will expect to acquire the interest at a discount.

In addition, the business may not have had sufficient time to best position itself for a sale and maximize its value.

Valuing A Business In Divorce

Valuing any asset during a divorce proceeding can be difficult and lead to significant disagreement between the spouses. A business interest is no different.

There are any number of ways to go about valuing a business during divorce. The correct method will depend largely on the parties, the industry in which the business operates, the operating history of the business, and the ability of the parties to justify their valuation.

One option is book value. This option is relatively straight forward in that you take the value of the business’s assets and subtract the business’s liabilities to arrive at a value.

But this fails to capture the value of goodwill or the value of the business as a going concern.

Another option is to value the business based on a multiple of sales or profit. The difficulty with this option is determining the appropriate multiple to apply.

Sometimes the spouses may agree to hire an independent appraiser to value the business. This can provide an independent third party’s opinion on the value of the business if offered for sale in an arms length transaction.

Even after a method of valuing the business is determined or agreed to by the parties, the process of valuing the business is not over. There may be discounts that should be applied to the valuation to account for facts arising from the divorce or the interest itself.

For example, a minority interest (say 30%) in a business is not necessarily worth 30% of the business’s overall value. This is because of what is referred to as a minority interest discount. Since a minority owner of a business has less control or say in its operations, that interest is often deemed to have less actual value.

Another example of a potential discount would be where the spouse losing his or her interest played a key role in the business. The loss of a key man or woman could cause you to discount the value of the business as a going concern.

The Impact of Buy-Sell Agreements In A Divorce

When individuals go into business with each other, they may execute a buy-sell agreement. The purpose of the agreement is to keep ownership of the business with those individuals or the business itself.

A buy-sell agreement sets forth specific trigger events that require the owner of an interest in the business to sell his or her interest to the other owners or to the business itself (a redemption).

A buy-sell agreement will often provide that the divorce of an owner mandates the sell of that owner’s and/or the spouse’s interest in the business.

A well drafted buy-sell agreement will also set forth the terms of the sale and the price or formula to determine the price that will be paid for the interest.

Assuming the buy-sell agreement was properly drafted and ratified by the owner’s spouse, a court will enforce the agreement. This means that the divorce court will only have jurisdiction to divide the proceeds from the sale.

Bryan Willis
Dividing A Business In Divorce
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