The Family Business and Divorce – Oh, What a Tangled Web We Weave
by Peter M. Walzer
Divorce is unpleasant for everyone, but for the owners of a family business, it is a disaster.
In a divorce, a couple not only has to dissolve the family as it once was, they also have to sell or divide their business. Untangling this snarl takes the Herculean effort of mediators, attorneys, accountants, appraisers, and, often, judges.
Businesses are treated as an asset in a divorce. There are many ways to divide the asset depending on whether the business is community or separate property or both. If the business was inherited or owned before marriage, it is likely to be a mixture of community and separate property. We address only the community property business here.
If the business is community property, one solution is to sell the business and divide the proceeds.
This solution circumvents the necessity of ascertaining the value of the business. But businesses are usually not sold in a divorce because selling a business is difficult and leaves one or both spouses without work.
The parties can also continue operating the business together or divide the business in kind. Although it is evident that ex-spouses cannot work together, economic realities may keep them together. If a business has more than one location, the parties can assign divisions of the business to each other and operate them independently. Even if the business is a pizza business with two locations, it is unlikely that both locations have equal value.
There would still have to be a financial offset to one of the spouses, which involves the expense of valuing interests in the business. Furthermore, the ex-husband and ex-wife may be competing against one another for business.
Issues such as who keeps the name of the business, who hires the key employees, and how to keep quality control with two separate and often antagonistic owners must be resolved. Because most businesses do not lend themselves to this kind of division, the business will likely be awarded to the spouse most capable of running it.
In most divorces, one party is awarded the business and ordered to pay the other for his or her community share in the business. The value of the business must be agreed upon or determined by a court. The value can be fair market value if there is evidence supporting that value, but more likely it will be the legal value of the business. The legal value does not depend on whether the business can sell or necessarily what other similar businesses sell for.
Absent an agreement, the value of a business will be a judicial officer’s decision based on the expert opinion of appraisers and accountants. It may be based on a rule of thumb or the investment value of the business, or any other legal method approved by the court. The usual components of value are the book value of the business, the accounts receivable and/or work in progress, and the goodwill of the business.
Untangling this Snarl Takes a Herculean Effort
There is a conflict in the law as to whether an agreement between the owners of the business fixing the value of a business is binding on a court. Although there is case law supporting the use of “buy-sell” agreements in the valuation of a business in a divorce, any agreement between spouses is presumed to be made with undue influence and therefore voidable.
To ensure that a buy-sell agreement is binding, the spouses must each be represented by independent counsel when the agreement is negotiated and there must be full disclosure of financial information relevant to the business. If spouses sign a buy-sell agreement, they are taking the risk that the company and the other owners will be joined in a future divorce proceeding.
Once the value of the business is ascertained, the community must be “equalized” with other assets of equal value by payment in cash and/or a promissory note.
This may result in one spouse being awarded the house and pension and the other spouse the business and/or one spouse owing the other a lot of money.
Funding the “buy out” will likely be a financial hardship, particularly considering that the new owner spouse is probably also paying support. Creative solutions that can enable both spouses to survive a divorce are necessary to encourage compliance with court orders and allow both parties to live comfortably.
The battle over the value of the business can be very costly. Attorneys’ and accountants’ fees can run into the hundreds of thousands of dollars. Divorcing couples are exploring methods of dispute resolution that will ameliorate some of these costs. To conserve resources, the parties may choose to agree to retain one appraiser to value the business with the option to bring in their own experts if they disagree with the result.
Couples may save money and preserve their relationship by using mediators to assist them in resolving issues, although the parties should each consult with an attorney before signing a mediated agreement.
There is also a process called collaborative divorce where the parties work together with their attorneys, accountants, and “coaches” to resolve their divorce in a cooperative manner. The benefits and risks of each method should be weighed carefully before choosing.
Before a person decides to divorce, they should think twice about the consequences. The break up of the family and the business may take years to unravel and many thousands of dollars. If they do take this step, they should avoid litigation if possible. The casualties in that ware are the family and the business