Dividing Business Assets in a Divorce
Breaking up (a business) is hard to do.
The number of small and closely-held businesses has increased over the years-and so has the number of business assets in need of allocation or division in divorce proceedings. This can make a divorce much more complex.
There are three scenarios that can typically occur when dividing a business in a divorce:
- Most often: The business is awarded to the spouse with the greater involvement and the other spouse is compensated.
- Sometimes: The court can order the business to be sold and the proceeds divided.
- Rarely: The business continues to be jointly operated by both parties.
Valuation and Compensation for Business Assets in a Divorce
In most cases, one spouse is substantially more involved in the business operations than the other spouse. In such cases, the court is most likely to award the business to the spouse who has the greater involvement.
Because it is most likely for a court to award the business to one spouse, the resulting issue in such cases is how to compensate the other spouse for his or her share of the business. In order to do this, the court will need to determine the value of the business interest that is being awarded to one spouse.
Because most marital businesses are small and/or closely-held, business valuation is frequently a complex issue. Most are not publicly traded on a public stock exchange (where the value of the shareholder interest can be readily ascertained). This means a closely-held business will need to be valued by a competent financial expert who is familiar with valuations in divorce situations. Experts who are experienced in divorce valuations usually provide a more accurate picture by excluding discounts that are not appropriate for divorce situations. Typically the financial expert is a Certified Public Accountant (CPA) with an Accredited in Business Valuation (ABV) designation.
The valuation process can be lengthy and costly in addition to being complex. It is important to work closely with divorce lawyers who are experienced in this area. It may be that a business has not generated sufficient income and/or does not have sufficient assets to warrant investing substantial funds in an expert valuation. An experienced attorney will be able to assist in making such a determination (it also never hurts to seek an initial opinion from a business valuation expert).
For an expert to ascertain the value of a business, he or she will need to review a variety of records to determine the business's income, expenses, assets and liabilities. The expected future income from a business represents a component of the business value, so even if the business has no other hard assets, the income alone may result in a significant business value.
If there are insufficient assets to fully compensate the spouse for his or her marital share of the business up front (which might be the case in situations where the business is the largest marital asset), the court may award the spouse a lien against future business income to ensure the spouse receives appropriate compensation.
Sharing Business Assets in a Divorce
In cases where the spouses have substantially equal involvement in the business operations, the court may still decide to award the business to one spouse or have the spouses continue to jointly own and operate the business.
In order for the court to determine that ongoing joint ownership and operation of a marital business is a good idea, both parties have to demonstrate that their involvement is important to the business and that they will be able to continue to work together as business partners even though they will no longer be married. This is extremely rare. In fact, if one spouse has to go to court to ask for shared ownership post-dissolution (over the other spouse's objection) the request will almost certainly be denied.
Selling the Business
The court can also decide to order the business sold, and may be inclined to make such an order if: a) neither spouse wants the business, or b) one or both spouses want the business but there are insufficient assets and income to fairly compensate the spouse who would have to leave the business. The court typically would not favor a forced sale of a viable business operation; it would order a forced sale in limited situations.
However, if spouses have the type of business relationship that will survive divorce, they will likely be able to resolve the property issues outside of court through mediation or other means.
Hidden Business Income or Assets
In situations where a spouse is taking steps to hide income/assets or make the business appear to be less valuable than it actually is, it may be important to audit certain records in greater detail. Although this can be costly, specific audits may reveal important information:
- Comparing historical records to more current records may reveal a departure from historical practice with respect to certain expenses. Perhaps a spouse is attempting to run additional personal expenses through the business in an effort to reduce business profits. Or perhaps a spouse has elected to make unnecessary capital expenditures in an effort to reduce apparent profits.
- Auditing personal records may also provide insight into the actual business income. A review of the business records alone may not reveal whether issues such as running a number of personal expenses through a business have occurred. However, a review of personal records would reveal the absence of certain expected personal expenditures and may warrant an adjustment to the stated business income.
- When valuing a cash business, reviewing personal financial records can be extremely important. The marital expenditures may substantially exceed what has been reported as business income-meaning that certain cash payments were never reported.
- Loan applications completed by the involved spouse either for business or personal loans might also provide information helpful to a business valuator. This is especially true if the involved spouse is takes the position that the business has no value or declining income.
Securing an accurate business valuation is important-especially when one spouse is relying on the valuation to receive an equitable distribution of other property to compensate for the business being awarded to the other spouse. Once the value of the business is determined, the spouse who is not being awarded the business will be awarded a greater share of other assets in order to compensate for his or her marital share of the business.