No one wants to think about divorce, but with almost 50 percent of all first marriages and close to 70% of subsequent marriages in the U.S. ending in divorce, the savvy business owner needs to think about protecting this major asset.
If you worked hard to build your business alone, you don’t want to risk losing part of it to a spouse who has contributed very little to your success.
Your Business May Be At Risk In A Divorce
The primary question when it comes to dividing assets in a divorce is whether the asset is separate or marital property.
In New York, separate property includes:
- Property that was owned prior to the marriage;
- Gifts received by one spouse from a third party;
- The pain and suffering portion of a personal injury judgment
Separate property can become marital property if you commingle it with marital property. For example, if you deposit your inheritance into a marital bank account it becomes marital property.
Any property that does not meet the qualifications for separate property and is acquired during the marriage is usually considered marital property regardless of how the property is titled.
So if you buy an apartment during the marriage, it is still considered marital property even if the deed is only in your name.
In New York, if the value of separate property increases during the marriage, that increase may also be considered marital property.
For example, if you started your business before marriage but your husband helps you get new clients, he may be entitled to a portion of the increase in value.
How To Protect Your Business From A Divorce Before or During Marriage
The best time to take action in protecting your business from divorce is before marriage or very early on. By planning ahead you’ll have the opportunity to implement pre-emptive strategies that will keep you in control of your business.
There are several strategies you can use before you get married or early in your marriage to protect your business from divorce:
Sign A Prenup
The most effective way to protect your business from divorce is to designate it as separate property in a prenuptial agreement.
A well-written prenup will ensure that your business remains separate property no matter how much your spouse contributes.
If you have a prenup, you should still employ some of the other strategies as a backup, but as long as your prenup is valid your business will be covered.
Be sure to use an attorney experienced in divorce for business owners who will know exactly how to word the prenup to keep your business fully protected.
Sign A Postnup As Soon As Possible
A postnuptial agreement is exactly the same as a prenup but it’s signed after the marriage.
Postnups are most effective if they are signed long before the parties file for divorce. A postnup entered into right before a divorce might be questioned. The best practice is to get it signed early in the marriage.
To ensure that your pre or postnuptial agreement is enforced, it is best that both parties have the agreement reviewed by separate attorneys.
Create A Buy-Sell/Operating/Partnership/Shareholder Agreement
If your business is a partnership, LLC, or corporation, you should have a buy-sale, operating, partnership or shareholder agreement in place that has a provision that defines what happens to the business should any owner get divorced.
Such agreements may :
- Require all partners/owners have a prenuptial agreement that waives their spouse’s interest in the business
- Limit a spouse’s ability to acquire ownership
- Deny the spouse voting rights
- Prohibit an owner or their estate from transferring or selling any ownership interests to third parties without written consent of the other owners
- Give the business or other owners with the mandatory right or right-of- first-refusal to buy the ownership interests from the ex-spouse of an owner.
Put The Business In A Trust
The idea here is that by putting the business in an irrevocable trust means it won’t be considered a marital asset since the trust, not you, actually owns it.
While this may work if you put the business in a trust before marriage, if you do it after the marriage and the business was previously considered marital property the court may consider it a fraudulent transfer. In this situation, the trust could be dissolved or you could be ordered to pay your spouse their portion of the business.
The other downside is that you can’t take back (revoke) an irrevocable trust so the business will be in the trust forever.
This option can be complicated so you should discuss the repercussions with an attorney.
Keep Your Spouse Out Of The Business
If your spouse is not involved in your business, it’s best to not let them start and if they are already involved you should try transition them out as soon as possible.
Unless you have a prenup, your spouse’s involvement in the business can strengthen the case that they are entitled to a larger portion of the business.
As the business owner, the outcome will be much better for you if your spouse was excluded from the start.
Keep Finances Separate And Pay Yourself A Real Salary
Keep the marital finances separate from those of the business. This goes back to commingling. If the business is separate property and you invest marital money, your spouse may now be entitled to a percentage.
You should also pay yourself a realistic salary. Many business owners pay themselves little so they can put it all back into the business. By doing this you spouse has an argument that money that should have been going to the household was going back into the business and therefore they are entitled to a bigger portion of the assets.
How To Protect Your Business From Divorce When Divorce Is Inevitable
Get A Valuation
The court will usually order a court-appointed valuation, but many business owners choose to have independent valuations to verify the number. It could also be a good idea to get a valuation done prior to starting the divorce so you are better prepared for planning purposes.
Sacrifice Other Assets
One way to protect your business from divorce is to sacrifice other assets to keep it.
This may be a good option if the business is clearly a marital asset and you have other valuable assets that you are willing to give up. You can agree to give up the marital residence, retirement accounts, or other financial assets in order to keep the business.
Buy Out Your Spouse
Often business owners must buy out their spouse. In many cases, the business does not have the liquidity to pay a lump sum so the business owner makes arrangements to make any payments over time using the business’s cash flow or a bank loan.
You can also raise buyout funds by finding investors or selling a minority stake in your business.
Sell The Business And Divide The Sales Price
The last and least desirable option is to sell the business and divide the sales price. For many couples, the business is their only asset and there is no other way to buy out the other spouse.
It’s a difficult situation, but you may be able to use your share of the proceeds to start a new business.
Divorce as a business owner can be tough, but with the right tools and information, you can protect what matters. To learn your options schedule your business protection strategy session today.