If you have your own business and you’re ending your marriage, then you’re going to want to know what happens to your business in divorce.
Probably about half of my clients either have their own business or their spouse is self-employed and there’s a huge variety in what those businesses look like. I’ve seen blogs that are strictly a side-job that probably cost more to run than the revenue they generate, I’ve seen an Etsy site that generates over $100,ooo annually, to a consulting business with no employees, no assets and a healthy revenue, a well-established construction company, a medical practice, a tree service company ….
When the business isn’t making any money, people do often agree to ignore it but that’s not smart – there’s always one thing you should do…
When the business has hard assets or if you both invested in the start up costs, then you’ll likely want to discuss how the current value of the business is to be divided…
And how does this impact spousal support?
If all this sounds complicated, it is. And when it comes to valuing a business a quick Google search will tell you that it is not black and white. Ask three different professionals for a value and you might get three different answers from each of them. So what are you supposed to do? Where do you start?
Considering how often this situation comes up with my clients, I’m surprised that I haven’t written about it before now. I know this is an important topic and I’m excited to be joined by Chicago-based attorney, mediator and divorce adviser Karen Covy for this Converation about what happens to your business in divorce. You can listen in below (email subscribers click here) or, if you prefer … keep reading.
Is The Business A Marital Asset?
The first step in figuring out what happens to your business in divorce is determining if it is a marital asset. It’s not as complicated as it sounds.
“If someone created the business during the marriage, it’s a marital asset.” said Covy.
If you already had the business before you were married, then the business, up to that point is a separate asset. So the business itself then is a mixture been separate and marital property.
The business is a marital asset even if your spouse played absolutely no role in it and that can be difficult to accept.
“There’s something about that that feels inherently unfair,” said Covy. “You did all the work, you put in all the blood, sweat and tears. It’s your baby but it’s still a marital asset.”
Conceptually, it’s similar to the person who works for a company. All of the income and benefits from that employment are marital assets even though the other spouse had no involvement with that job.
If anyone else is involved in your business, then hopefully you have a written agreement that spells out how that impacts the ownership of the business. If, for example, you have a partner and you’ve agreed you are 50/50 owners of the business, then simplistically 50% of the business is a marital asset.
Is The Business Worth Valuing?
Covy says that formal business valuations start at $5,000 so the first step is to decide if your perceived value of the business warrants spending that kind of money to get an independent valuation.
A business that is knowledge-based, with few assets beyond a computer, with no employees may have no value beyond the income that gets generated and you might agree in this situation to forgo a formal valuation. You might also argue that the client-base is an asset that could be sold and so has value. But even that is not straight-forward. Some businesses are prohibited from selling their client list. For others, the client list could be sold but the question then is will those clients stay with the new company, if the previous owner is no longer involved.
“There are many different ways to value a business,” said Covy. “But no matter the approach, the value is what a willing buyer will pay to a willing seller on the open market.”
Even if you are financially literate, Covy believes that most people would find it helpful to have a financial person review the business’s tax returns and financial statements. They would be able to tell you what revenue is being generated, what’s really going on and if there is any worth independently of the owner. With this assessment, you would then know if investing in a third-party valuation was called for.
What About Start Up Expenses?
Every business has start up expenses and these may have been paid for from household finances, especially if they were put on a credit card or charged to a home equity line of credit. Even if the business has no tangible value, these still represent an investment by you in your spouse’s business (or vice versa) and you can request that you be reimbursed for these.
Such reimbursement could be made as a series of payments over time, secured with a promissory note. Covy recommends that whatever agreement is made for reimbursement, is included in the divorce paperwork because that then becomes a court order and enforcing a court order is easier than the process for enforcing a promissory note.
Review The Financial Records
To get even a basic understanding of a business, you need to review the financial records – that means tax returns, the balance sheet and the profit and loss statement. It is a sad reality however, that for many small businesses, these records are an after-thought or woefully incomplete.
I’ve seen people running a business with no formal separate legal entity. I’ve seen businesses where there is no separate bank account. I’ve also seen a business where the only record of sales and expenses is a file folder with receipts. And, yes, there’s the cash transactions that don’t get recorded.
And it’s not just record-keeping that can be lacking. It’s common for non-business expenses to be paid from a business account and business owners have a great degree of latitude.
There may not have been an explicit agreement between you and your spouse to run household and personal expenses through the business, but if those expenses are not hitting the household accounts then there’s a tacit agreement.
These practices may have been going on for years and this makes valuing the business more challenging. Certainly, if business expenses weren’t so high, then the net revenues would be more and that would impact discussions about spousal support.
Without a separate bank account for the business, someone is going to have to go through all your personal financial records, such as bank statements and credit cards, and create business records, one transaction at a time.
Another common situation is a business that is doing well up until the divorce and then all of a sudden, it’s losing money, revenues are down, there’s heavy capital expenses and there are times when this is absolutely intentional.
“It’s never 100% clear,” said Covy. “The truth is that one of the best places to hide money is a business.”
Impact On Spousal Support
Any business is two things: an asset and an income. An asset means it’s worth something on the open market. An income means that it generates revenue. It’s that income part that comes into play with spousal support.
Covy cautions that the law with respect to spousal support varies from state to state and even jurisdictions within a state so there is not clear cut answer.
What we want to avoid however is a “double-dip.” That would be a situation where someone receives spousal support and a property settlement for the value of a business and that property settlement already includes a consideration for income.
Covy explains that an example of this situation could be one where there is a goodwill element to the business valuation that goes over and above hard assets, like equipment and tools. Let’s say Dr. Smith has a medical practice. The reason why clients got to Dr. Smith’s medical practice is for his reputation and expertise. Valuing Dr. Smith’s reputation is considered goodwill. Including Dr. Smith’s goodwill in the business valuation, for which there is a property settlement, and then expecting Dr. Smith to pay spousal support may be a double-dip situation.
A Business Is Also A Liability
In addition to being an asset and an income, any business is also a liability. This applies to all businesses even if you’ve determined that it has no value and even if it is not generating a profit.
There are two things you need to make sure are in your divorce papers. First, if you own the business, then you want it documented that the business is 100 percent yours, that you get to keep it, and that all of its assets and income is your sole property. This establishes the business as your separate property after the divorce and will protect you from future claims by your STBX to your business.
The second element is often overlooked by people who are doing their own divorce but it is absolutely critical. If your STBX has a business then you want the divorce papers to state that your STBX is responsible for all debt related to the business and will indemnify you and hold you harmless from these debts and any liability claims that might arise in the future. This needs to be broad enough to include liabilities arising from tax returns that weren’t done properly.
If all this sounds complicated, it could be but it points more to the importance of getting competent, professional advice and with unbundled legal services, it’s not going to cost you an arm and a leg to do this.
“If you have a business, there is no reason why you wouldn’t spend a couple of hundred dollars to sort this out on the front end rather than being sorry that you didn’t do that on the back end,” said Covy.
My guest for this Conversation was Chicago-based attorney, divorce adviser and mediator, Karen Covy. You can learn more about Karen at her website where you can also download her free divorce toolkit.