Business owners face unique challenges when going through a divorce.
For those who own a business, there may be concern about if and how the business will be divided.
Is the former spouse entitled to half of the business?
If you own a business and are wondering what will happen to it in a divorce, read on to find answers to your questions below.
The Business Must Be Evaluated
Before you can determine how your business can be divided, the business must be evaluated. A business is an asset just like any other asset in a marriage such as a house or car. Accordingly, determining how it will be divided is based on the same two step process applied to any other marital asset—characterization and valuation.
- Characterization – Means determining what type of asset the business is. Is it community property which can be considered jointly owned, or is it separate property that is considered your personal asset and therefore not subject to division upon divorce, or is it some combination of each?
- Valuation – Means determining what the business is worth in terms of dollar value. Valuing a business is a complex process where a financial expert reviews records relating to the entity’s income, assets, expenses, liabilities and expected future income in order to determine the value of the business.
These evaluations will determine if your spouse is entitled to part of the business, and if so, how much. Knowing this fact can cause panicked business owners to take foolish steps in an attempt to make the business look less valuable and profitable. Don’t do it! The best thing you can do is research family law lawyers and choose one that has knowledge of both divorce and business law.
Three Methods of Dividing a Business in a Divorce
In the end, if the business is determined to be either full or partial community property, it will have to be divided to compensate both parties. There are three main methods the courts use to divide a business.
1. One Party Gets the Business and the Other Gets Financial Compensation
This is the method that is used most often to divide a business. In these cases, the spouse who has greater involvement in the business will be awarded the business itself.
For example, if you own a law or medical practice, a court is likely going to award you 100% of the business because the business is essential to your livelihood and your spouse is not qualified to run such a business. Your spouse will receive compensation based on the characterization of the business and its valuation.
To illustrate, if your interest in the business is valued at $100,000 and you are awarded the entirety of the business, then the court will compensate your spouse for her interest in the business–$50,000 assuming a 50-50 division—by awarding her some other martial asset of comparable value (a retirement account, perhaps). Or, in the absence of some other marital asset of comparable value, she may get a $50,000 money judgment in her favor that you will have to pay her according to specified terms (monthly payments over a number of months or years).
The characterization process determines how much of the business is community property so it can be split fairly. Characterization will take into account whether you acquired the business before your marriage or after.
- If the business predates the marriage, divorce lawyers and valuation experts will consider the value of the business at the time of the marriage, how long before marriage the business started, and how the business has performed since the marriage. Even if it is determined that the business is your separate property, income from separate property is still considered community property.
- If the business has been passed down by a family member, divorce lawyers and valuation experts will consider things such as whether it was a gift or purchase, what percentage of the business you own, and whether others maintain ownership interests.
- If you own the business with a business partner, divorce lawyers and valuation experts will separate what you own from what your partner owns.
As you can see, each scenario is different so divorce lawyers and valuation experts will take into account the unique circumstances of your business. Using these facts, characterization and valuation will be determined, and fair financial compensation to the spouse will be awarded
2. The Business Is Sold, and the Proceeds From the Sale Are Divided
This scenario happens sometimes, but it is not at all as common as the first scenario. Typically a business is sold if there isn’t agreement about who should be awarded the business.
For example, in some cases, both spouses may be entitled to the business, but neither wants to claim ownership. In other cases, both spouses want the business, but the business doesn’t generate enough income to provide fair compensation to the spouse who does not get the business.
Selling the business can be difficult because it can often take months to find a buyer. However, divorce lawyers say in some cases, selling the business is a good idea. It allows each party to gain profit from the sale, and then each can use that profit to set up their own businesses once the divorce is finalized.
3. The Business Continues to Be Jointly Owned and Operated by Both Parties
Co-ownership is the final way of dividing a business after a divorce. It is rare for obvious reasons – two people who no longer want to be married and live together rarely want to continue working together as business partners.
That said, in rare cases co-ownership can work out. For the court to decide that joint ownership is the best solution, both parties must:
- want the business,
- demonstrate that they play a crucial role in running the business and making it successful,
- and they must also show they can work together in the future as business partners.
Central to determining the value of a business and how a business is divided is the form of business—is it a corporation, partnership, or sole proprietorship?
Partnership property is owned by the partnership entity, not the individual partners and is, therefore, neither separate nor community in character.
The only partnership property right the partner has which is subject to a community or separate property characterization is his interest in the partnership—his right to receive a share of the partnership profits and surplus.
Distributions of the partner’s share of profits and surplus (income) received during marriage are community property even if the partner’s interest in the partnership is separate property.
Similar to a partnership, property owned by a corporation is neither separate nor community property. A court may only award a spouse’s interest in the corporation.
If the business is a sole proprietorship established during the marriage, then all of the business assets are considered community property.
Need Help With Your Divorce or Business?
This article has explored the main questions most people have regarding how a business is divided in the case of a divorce. However, you’ll notice there is no ‘one size fits all’ answer because it depends on the characterization, valuation, and specific circumstances of the business in question. For this reason, divorce lawyers play a crucial role in helping to assess the situation and come to an equitable resolution.
If you own a business and are considering a divorce, contact the Law Office of Ben Carrasco today at (512) 320-9126 or request a consultation online.