In our previous post we discussed the many ways that stakes in businesses, from a small one person shop to a larger corporation, become subject to division in divorce. In this post, we discuss ways an owner can insulate much of the business from an equal division.
The most important step in protecting a business is its corporate structure. A sole proprietorship has no protection; a publicly traded corporation has a defined stock interest. In between you have partnerships and close corporations. In general, a spouse will have a claim to half interest in the business created and/or grown during the marriage. However, that interest can be limited by corporate structure. For example, if a business interest required a venture capital investment, that investor may own half the company (just watch Shark Tank for one episode). The total spouse interest is not the whole value of the company but the percentage of ownership. Avoiding complete ownership of the business means less of the pie to divide come divorce (of course, it also means less control and could represent a sale of interest to which the other spouse has a claim).
So corporate structure gives some help; corporate agreements do more. Partnership agreements and stock transactions can specifically state who has ownership, and can limit the value a spouse can take if the spouse is also part of the business. So, if husband and wife start a business together and agree to a 60-40 interest, that contract generally governs the interest in the company (but may not prevent the lesser share spouse from trying to argue in family court for more). Another option: an employment agreement that gives a spouse an income and a defined interest in profits or corporate ownership based on years of service or other measures.
Most people do not take these steps early in the process. Can they still get protection?
Yes. The best option is always a prenuptial or postnuptial agreement that sets out precisely what interest each spouse has in a particular business venture. It is the strongest defense to assure the business creating spouse retains most of the profit of the business.
If you do not use some form of contract to specify and limit ownership, the entanglement can be a nightmare. For example, if the business starts with money from a joint savings account or a mortgage on the marital home, the whole business starts as a 50-50 venture. The more the entanglement of marital assets with the business, the more both spouses get equal claim. Similarly, the more each spouse has a prominent role in the company, including salary, the more each spouse will have a claim to a major stake.
So, if you find yourself growing a business and concerned about the dual involvement, the best step to take would be to ease the other spouse out of the business – reduce that spouse’s role, that spouse’s salary, even that spouse’s stock take.
If it comes to a divorce and the parties have too much entanglement, the best move at that point is to keep the business strong for both parties’ sake as they rely on it for income and retirement. If the business collapses with the marriage, it could ruin everyone financially. So, rather than tear up the company, reach some buy-out agreement so that only one spouse has full control and the other spouse has a fair valuation of that spouse’s interest in the company – and do it in a way that does not drain the company of cash to continue operating.
As you can see, the potential for problems in business ownership and divorce can be significant and severe. It requires strong advance planning or solid creative thinking at the time the marriage dissolves.
If you have questions about business ownership and divorce, contact us – we can help.