Divorces can be an inevitable event for some individuals. It is a tedious, emotional process that can be drawn out depending on the circumstances. When talking about the aftermath of a divorce, it can have many different impacts in a person’s life; such as properties, assets, child custody, finance, and more. A divorce is a legal termination of a marital status between two individuals. However, results from a legal separation may affect more than just a couple’s property and assets.
For instance, from a business standpoint, complications may arise when a divorced individual owns assets that are tied to a legal entity, or even shared with several people, such as a partnership or a shareholder. Hence, a business can be one of the most complex areas when going through marriage dissolution. To best protect assets and to make the process of divorce easier, it is important to understand the implications that a divorce may potentially have on a business and its partners.
What is considered property?
To understand the effects that a divorce has on a business and its partners, a person must first understand the different types of property in a marriage. Property is generally anything that can be bought or sold such as;
- House
- Vehicles
- Furniture
- Artwork.
Moreover, the property can also be anything that has monetary value such as;
- Financial accounts
- Income
- Pension plans
- Stocks
- A business
- A patent
Community Property States
California, along with 8 other states such as Arizona, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin, are community property states. Community property states dictate that through marriage or legal registration of a domestic partnership, couples jointly own marital assets. This plays a big role in the court’s decision of how property is divided in the event of a divorce.
Community Property and Separate Property
Community property states further categorize property into two types; community property and separate property. In California, when couples enter into marriage or are legally registered in a domestic partnership, all assets acquired during the marriage will be considered “community property”. This means all income and assets will be merged into one marital asset. Both spouses will own equal shares in each other’s assets. Additionally, any debt acquired during the marriage will belong to the “community debt”.
Generally, there are 2 exceptions to community property. These exceptions make up what is known as individually owned property or “separate property”. First, if the property or asset is received as a gift or passed down as an inheritance. Second, if a married individual owns or acquires the property before entering into the marriage or registered in a domestic partnership. If a couple has been legally separated, any assets acquired after the date of separation are also deemed as separate property. Hence, in the event of a divorce, community property will be divided in half between the parties, and separate property will go to whoever initially owned the property.
How does this tie into the business standpoint? Under California law, a business is recognized as property, and business interest will be considered as part of the marital asset. If a married individual starts a business during the course of a marriage, then all the business interest that accrued from that business will belong to the community property. When a marriage dissolution process occurs, both spouses will be entitled to 50% of the business’ interest value. However, it is important to note that a business interest value is not the same as having ownership of the business. In simpler terms, if your business partner gets a divorce, their spouse will not gain any ownership over a business. They will, however, receive interest value based on the business.
Could my business suffer after my business partner gets a divorce?
Businesses may potentially suffer from a divorce, whether it is your divorce or your partner’s. For example, an individual may have to give up 50% of the business to their spouse. Or in some instances, if your business partner gets a divorce, you might be expected to add their ex-spouse as another partner in your business. However, the answer will be different depending on each case. Typically, the first thing to determine is whether the business is separate property or community property. Next, individuals may need to explore the following questions;
- Was the business interest accrued during the course of the marriage?
- What was the source of funds that were used to acquire the business?
- How much financial contribution, if any, did the spouses put into the business?
- How much financial gain did the business expect over the span of the marriage?
Questions like this will narrow down the answer as to how much a divorce may affect a business as it helps to determine what is counted towards each individual’s separate property and community property. If the business was started before the marriage, and your business partner gets a divorce
How can I mitigate the risks of my business?
To start mitigating risks relating to a business, one must first have the correct plan:
Choosing the right business structure:
When starting a business, one of the most important decisions to make is choosing the type of legal structure for the company. Generally, this decision will have an impact on various aspects of the business such as tax implications, legal registration, paperwork, legal liability for each partner, etc. Additionally, in this case, choosing the right business structure can also mean the ability to protect and predetermine how business interest will be divided in the case of marriage dissolution. Another thing to keep in mind is courts do not generally have jurisdiction over the company’s internal organization.
Common protective business structures and agreements can include:
- Shareholder
- Partnership
- Limited liability company (LLC)
- Buy/sell agreement
These business structures and agreements are a great tool because they often allow business owners to include tailored provisions that aim to secure their business interest, in the event of when your business partner gets a divorce.
For instance, in partnerships, partners can choose to add partnership agreements that can include terms that restrict partnership-interest transfers. This will limit who the ownership can be transferred to. In the event that you or your business partner gets a divorce, this type of agreement can serve as a very useful tool in safeguarding partners from being stuck in doing business with someone they might object to.
Having pre or post-marital agreements
Pre and post-marital agreements are documents that will help individuals outline the property owned by each spouse. The main difference between the two agreements is that prenuptial is signed before the marriage, and postnuptial agreements are signed after the marriage. Prenups are usually more common and will uphold better in court. Some states do not recognize postnups and are typically judged under heavy scrutiny by the courts.
However, in several cases, couples enter into a marriage without prenuptial agreements. This is where postnuptial agreements come into play by allowing individuals to still outline ownership of their assets. In most situations, postnuptial agreements are used to update pre-existing prenups when the financial situation evolves.
Prenups and postnups cant fully guarantee to save all of your business from being divided. However, it will protect business assets to a certain extent by allowing individuals to designate future assets as separate property.
Evaluating the value of your business
If you or your business partner is getting a divorce, it is a good idea to get the business valued. Knowing how much a business is exactly worth will make the process of splitting up easier. Unlike the value of other assets that can simply be divided down the middle, calculating the value of a business can be much more complex. For the court to determine which part of the business are marital assets, several things must be taken into consideration such as, the date of acquisition in respect to the date of marriage, financial contributions made by each spouse, current and future gain, etc. Hence, it is common to hire a forensic accountant to provide a professional valuation of the business. A lot is at stake in a business, and the last thing that you want is for your business to be undervalued or overvalued.
There are three methods to determine a business valuation;
- Asset approach
This approach assesses the value of a business by placing a fair market value on what the business actually owns. The assets taken in computation may include but are not limited to things such as equipment, real estate, intellectual properties, etc. Two methods that are used to value a business by its assets include the asset accumulation method and the capitalized excess earnings method. - Market approach
Unlike the other methods that focus on the business’s actual financial gain, the market approach takes market value into consideration. In other words, the market approach considers how much the market is likely to pay for a business. Two main ways of determining the market approach are the comparative market transaction methods and guideline publicly traded company method. Briefly, how the method works is that it will take the value that like-businesses were sold for in the market to make an assessment. - Income approach (economic benefit)
Under this approach, the value of the business is calculated by its ability to produce a potential gain for the owners. There are three ways income can be valued; discounted cash flow, capitalization of earnings, and multiple discretionary earnings.
Under community property laws, if a business was started by a single individual before entering into marriage, then that business is regarded as separate property, belonging to the spouse who started it. However, it is often not that straightforward. Community property gives the right to each spouse to equally own half of each other’s assets that have been acquired during the marriage. Hence, it is very common that the business will lose its status as separate property during the course of a marriage.
For example, John is a sole proprietorship of XYZ. Once John married Alex, the company XYZ still belongs to John as his separate property because he acquired it before the marriage. However, during the course of their marriage, company XYZ has increased in value. Hence, the business interest can most likely be deemed as their marital property. According to the jurisdiction of community property states, if John and Alex were to dissolve their marriage, the marital property will be divided in half.
F.A.Q.s:
Q: What happens to a business if a partner gets a divorce?
A: California is a community property state, which means all marital property will be divided equally. In some cases, the spouse of the divorce partner might be able to take on half of that partner’s stake in the business. For example, your partner’s ex-wife may become a shareholder and may have authority in the decision-making process in the company’s business. However, this isn’t always the case because depending on each divorce, the courts will determine the division of property differently. So, in other cases, the court might consider the business as non-marital property, thus it won’t be divided 50/50.
Q: How to handle changing business ownership
A: In some stances, businesses can be deemed as marital property and an ex-spouse may be entitled to 50% of the entire business. Certain agreements such as divorce contingencies and shareholder agreements can limit the transfer of ownership. Generally, this is done by requiring the ex-spouse to sell the business interest that has been awarded back to the company.
Q: How to ensure that you are not personally liable for your business?
A: One way to limit personal liability in a partnership is by including a contingency for divorce or a shareholder agreement. Divorce contingencies limit what your partner’s ex-spouse can do with the company. For example, it can obligate the ex-spouse to sell the business interest that was awarded from the divorce back to the company. This will prevent current partners from being in a situation where they are stuck working with someone they may not want to work with.
Another way to limit personal liability is a shareholder agreement. Similar to divorce contingencies, shareholder agreements can include restrictions of ownership or transfers of the business interest. Additionally, it can further entail protective provisions like dispute resolution or in what to do when unfortunate circumstances occur, such as a shareholder’s death or falling out. This key in the effectiveness of shareholder agreements relies upon how it is drafted.
Hence, it is crucial for companies and business owners to consult a competent lawyer to help them create these agreements as soon as possible. Agreements can be drafted when setting up the company. Business owners shouldn’t wait for a divorce to occur to begin these processes.
Q: What to do if your business partner remarries?
A: In the circumstances where a business partner remarries, other partners should rely on the same protective strategies such as shareholder agreements, contracts, and divorce contingency that should already be in place. Otherwise, partners should act on drafting new agreements as soon as they know about the partner’s remarriage to ensure that protective measures will be effective and enforceable.
Q: How to prevent future conflict in your business and personal relationship?
A: To prevent future conflicts in a business or personal relationship from a divorce, you can enter into several agreements. For businesses, partners can draft shareholder agreements, divorce contingencies, and other contracts. In marriages, individuals can enter into marital agreements such as prenups and postnups to keep marital and separate properties apart. This is crucial because in the events of a divorce it will determine how the assets will be split up. An essential part of effective protective measures is making sure they are put in place before the divorce occurs. It’s often never too early to protect business and assets, but it can often be too late.
Contact Pride Legal
If you or a loved one has been looking to secure their business, assets, or have been wanting to acquire a postnuptial agreement, we invite you to contact us at Pride Legal for legal counseling or any further questions. To protect your rights, hire someone who understands them.