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Could You Lose Your Business in a Divorce?
Credit.com August 7, 2015
Divorce can be stressful enough. Trying to figure out who gets what can make it even more stressful. And thinking about dividing an asset that isn't readily divisible can sometimes scare people into staying in bad marriages, or maybe crawl into a cave somewhere.
While divorce is never fun, the good news is that if you and/or your spouse own your own business, you can still get divorced and the process does not have to be nearly as painful as you might think.
To determine how a business is divided, we need to start from a point a little further back in the process. In any divorce, one of the main jobs a court has to do is to put everything the parties have into three distinct "piles." His. Hers. And Theirs. (Obviously with gay marriage now legal, we will be seeing "His, His and Theirs" and "Hers, Hers and Theirs," too – but I digress). The His and Hers piles basically will be assets that were premarital, or inheritances that were kept separate, or nonmarital gifts. The Theirs pile will be everything else, including any assets that were acquired during the marriage. In equitable distribution states, which most states are, this pile will be "equitably" distributed. Equitable, of course, means fair. So in these states, the court will start from the premise that there will be a 50/50 split but there are sometimes reasons that the split may be "unequal" to achieve an "equitable" result. In community property states, equal is usually the path of choice. (Here's a guide to what can happen to your credit in a divorce.)
What does all of this mean with regard to your business? First, an analysis must be done about the business in general. A business that is started during the marriage will be presumed to be marital – and thus part of the Theirs pile. This is regardless of whether the name of the business is in both names or in just one of the parties' names.
In these cases, an expert in valuation will look at many factors to determine what the value is for divorce purposes. The gross income, while one of the factors to review, may not necessarily have anything to do with the actual value. The expert will look at the actual assets of the business, the accounts receivables, how marketable the business might be to others, and many other indicators of value. If the business is fully marital, then there are really only three choices in a divorce: 1) One party buys the other one out; 2) The business is sold and the net proceeds split; 3) Or the parties keep owning it together (the least practical choice for obvious reasons).
If the business was started prior the marriage, then it is slightly more complicated. The expert valuator will then have to determine what the value was on the date of marriage, and what the value was on the date of petition of dissolution of marriage was filed, and the appreciated value (if due to the efforts of either party) is then considered marital and literally carved off and that value goes into the Theirs pot. The value at the time of marriage is also carved off and put in either the His pile or the Hers pile (depending upon whose premarital business it was).
Another piece for the expert valuator to consider is the concept of "goodwill." In general, the goodwill part of the value is broken up into two different kinds of goodwill: personal and enterprise. Enterprise goodwill has to do with the value of the enterprise, separate and apart from the divorcing party. For example, if the couple owned a MacDonald's franchise, a lot of the value would be in the enterprise, not so much in the owner of the franchise. Conversely, personal goodwill is the value of the person to the entity. A good example of that would be a small law firm that bears the name of the attorney. Most often in that instance, clients hire Joe Schmoe of the Law Offices of Joe Schmoe, because they have been referred to him, or heard he is a great lawyer. Therefore, if Joe Schmoe sold or left that law firm, the value might drop significantly.
Another way to look at the concept of personal vs. enterprise goodwill: Would a potential buyer be interested in the company because it would hold its value even after the current owner is gone? The importance of this is that in most states personal goodwill is a "non-marital" asset and enterprise goodwill is a "marital" asset. One part of the value goes into the Theirs pile and the other does not. Coming to a conclusion of exactly what each part is worth is the more tricky part, and the part that many experts end up battling out in front of the judge.
Obviously, this is a simplified way of looking at what happens to a business in divorce. But essentially, this is the process. While it can sometimes be a bit tedious, rest assured there is no business in the world that so rare, complicated, large, or different that it can't be classified and the value divided in divorce.