As a business owner, you’ve probably heard, "It must be nice to set your own hours and be your own boss.” Or, “Hey, you own your own business, why don’t you pick up the check?”
And my personal favorite…“So, what’s it like to be rich?”
If they only knew…
The truth is, business ownership is not nearly as glamorous as your friends and family might make it out to be.
You’ve made a lot of sacrifices to get where you are. In many cases taking years, if not decades, to build a business or professional practice you can be proud of.
And that’s finally profitable!
But now that you’re divorcing, you have questions about how to determine what the business is actually worth, the best way to divide a business in a divorce, how to define what percentage of the business is considered marital property, and just how to get the best outcome in a divorce with a business involved.
You want your agreement to balance both of your interests while acknowledging the scheduling challenges, compensation, and income complexities unique to a self-employed entrepreneurial lifestyle.
And at the same time, prevent outsiders from destroying everything you’ve worked so hard to build!
There are a few things you need to understand about the challenges of divorce and owning a business:
There’s more than one business valuation method and the various methods can produce wildly different results;
The best method to divide a business in a divorce isn’t the same for everyone;
Determining what percentage of a private business is considered marital property can also be difficult;
Parenting time, child support, and spousal support can all be unwittingly impacted in a business owner divorce;
Divorce with a business involved has less to do with laws and more to do with money and negotiation;
There is more than meets the eye on this topic and this issue is much too complex for you and your spouse to try to resolve on your own.
If you're divorcing with a business involved, you'll get the best result by mediating.
"Divorce with a business involved is like an iceberg. It’s not what lies above the surface that can sink you, it’s what’s lurking underneath.
That’s why it's better to work with an experienced divorce mediator with financial acumen and who is also a business owner, like me."
There’s more than one method for valuing businesses and the various methods can produce wildly different results.
It’s a common misconception when getting a business valuation for divorce purposes, that business valuators will produce a report with a single value for your business.
After all, why would your business have more than one value? When you go to the supermarket and need to buy bread, the same loaf of bread doesn’t have three different price tags, does it?
Of course not.
Yet that’s exactly what can happen when getting a business valuation for divorce.
At a high level, the three methods are:
The Cost Approach which is based on the fair market value of a business's net assets;
The Market Approach which values a business based on what other similar businesses have sold for in the recent past;
The Income Approach which uses projected earnings to derive a present value for the business.
Depending on the type of business you have, one approach may be more suitable than another.
Add to the mix that each of these valuations can produce wildly different results. And in some of the mediation cases I’ve had, one of these methods may show a positive value for the business, while another may show a negative value.
How do you reconcile that?
Let’s say you’re one of the 28% of Americans who is a small business owner and you want to sell your business ownership – and in this example, you’re NOT also getting a divorce. Naturally, you'd want to use the valuation method that resulted in obtaining the highest sales price for your business. And your spouse would want to use that valuation method, too.
But since you are getting a divorce, and your business will become a marital asset (subject to community property division, such as in a Washington State or California divorce, or equitable distribution, such as in an Illinois, New York, or New Jersey divorce), you might want to use the valuation method that resulted in the lowest business' value.
You and your spouse are now immediately at odds.
And if each of you has a divorce attorney representing you, naturally, they’re going to argue for whichever business valuation is best for their client.
Which in the blink of an eye can turn your asset into a liability!
Do you own a business? Or are you the business?
Let’s say you’re a financial advisor and run a small investment advisory firm. Your business is a success because of the relationships you built with clients over time – as well as the licenses you have that allow you to run such a business.
Now you need a business valuation for divorce. But the value of your business is based on your efforts and relationships.
So what happens if:
You take all your clients with you, or
You’re the only person that brings in business income, or
You’re the only one licensed to perform the service,
What value does the business really have?
Without you, maybe there is no business. And in turn, no value. This is what I call the “Key Man problem.”
Did you reinvest in the business in lieu of taking a salary?
It’s not uncommon for the self-employed to invest everything they have into growing their business. And that might even include not taking a salary.
Maybe you thought, “My spouse has a good job, so I’ll rely on him/her to pay the bills and cover us financially – and I’ll forego a salary and instead, reinvest any profits into my business.”
So that’s what you did. And as a result, your business grew more quickly than it would have had you been taking a salary.
Now there are a few problems:
First, had you drawn a salary, there would have been less money available to reinvest into your business. And as a result, the growth rate of your business would have been slower.
Leading to a lower valuation at the time of your divorce.
Second, at the time of your divorce, because your business value would likely be inflated, you may have had to offer your soon-to-be ex-spouse more of your marital property / assets to come to an agreement you both found fair.
Third, because you’ll no longer have your spouse to support you after you're divorced, you’ll have to take a salary.
Which leaves less cash available to reinvest into growing your business.
Over time, due to the slower growth rate of your business, and the fact that you had to give up (more than you should have) assets to keep your (inflated in value) business, it may have delayed your retirement and “forced” you to remain working for longer than you had originally planned.
Starting to see why business valuation and divorce can be a very complicated issue to resolve for a divorcing couple?
The best method to divide a business in a divorce case isn’t the same for everyone.
Just as there are various methods to value a business, there are also numerous options for how to divide a business in a divorce. And the option you choose is entirely dependent on your unique situation.
Here are a few examples…
You could sell the business.
On the surface, this might seem to be the easiest way to go. Whatever proceeds you receive from the sale you and your spouse could divide as you see fit.
But selling your business can come with challenges. For example, what will you do to earn money after you sell?
This will be important for not only covering your own living expenses but also if you are required to make child support or alimony payments as a result of your divorce.
You could continue to co-own the business.
Another way to "divide" a business may be to not divide it at all!
If you and your spouse are getting a divorce when you own a business together, and you each play an active role in operating it, you may wish to leave things as-is.
On the surface, this may seem like a good idea as it eliminates the need for a valuation at the time of your divorce. And removes this asset from your divorce negotiations.
It also allows each of you to enjoy the "perks" of the family business, maintain your current salaries, and share in the net profits of the business.
But... you're getting a divorce. And in my experience, "communication challenges" are a major contributor to the reason for ending a marriage.
So divorce and owning a business together could be difficult, or impossible! Will you and your soon-to-be-ex still be able to effectively communicate as co-owners, and agree on a future direction for the company knowing that your financial and lifestyle goals may no longer be aligned?
And even if you think you can, do you really want to be involved in each other's post-marital lives?
You could buy out your spouse's business interests.
Buying your spouse out of the business may seem simple enough – you would get to keep the business and they would get to keep other comparable tangible assets or marital property.
But in order to provide a basis for the negotiation of the buyout amount, a valuation will be required. And it’s entirely possible that the amount could be higher than what you could actually sell the business for on the open market.
I once had an economics professor who taught me that the right price for something is the amount someone else is willing to pay. Meaning: a valuation and an actual sales price, can be two entirely different things.
Since you are not selling the business on the open market, you really don’t (and won’t) know what the true sales price (and net proceeds) would be.
But the problem is that your ex may now expect you to buy them out of the business using the valuation amount.
And given your experience in your profession, you may not think that value is realistic.
Leading to an inability to resolve this issue.
Determining what percentage of a private business is considered marital property vs. non marital property can also be difficult.
Is the business a marital asset or a separate asset?
Did you start your business during the marriage or prior to the marriage?
If you started your business prior to the marriage, do you know what its value was at the time you got married? Did you have your business valued at that time?
Did you invest any marital funds into the business? Or was it all done separately, apart from the marital estate?
Did the business grow during the time you were married? Is that portion of the business marital and therefore subject to division?
Even if on the off chance you had a prenuptial agreement or postnuptial agreement in place outlining each spouse’s business interest in the event of a divorce, a good lawyer could likely rip it to shreds.
Did you start the business, then after you got married, your spouse started working in it?
Some couples decide to start a business after they get married, and work in it together. In that case, there's no question 100% of the business is a marital asset.
But let's say you started your business 5 years before you got married. Then, after 7 years of marriage, you decide your business has grown to the point where it could support another employee.
So you say to your spouse, "Congratulations! You're hired!" and they join the business full-time.
After 4 years of working together, the pressure proves to be too much. Your spouse quits, asks for a divorce, and expects to get their share of the business when it comes time to divide your property.
The question now on the table is do you know what share of your business is marital, pre-marital, or even non-marital (that is - the time only you worked in it even though you were married)?
Is it based on:
The number of years each of you worked in the business?
The revenue the business generated?
The value you each provided to the operations and/or bottom line?
All of the above?
If this is starting to sound like one of those math word problems that gave you nightmares in school, that's because it is.
And there's no one size fits all answer to the question.
Or is your spouse a business owner “in name only?”
Some businesses assign an ownership interest to each spouse, with one spouse being an owner “in name only” (INO) - meaning they don’t work in the business on a day-to-day basis.
What happens then?
For example, in the case of a divorce and LLC business, does the INO spouse get a share based on what is outlined in the membership agreement?
And what if your spouse has no ownership at all? Can they get a share then?
What if they performed other tasks during the marriage such as childcare, or held down the fort at home while you were off building the business?
Without your spouse caring for the kids and/or managing the house, you may not have been able to grow your business into the successful entity it is today. So while they may not have worked directly on or in your business, they may certainly have had a hand in its success.
Do you have a business partner?
Business ownership isn’t just sole proprietorship as some people choose to start a business with a partner or partners who are not their spouse.
For example, in the case of a divorce and an LLC business, the Membership Agreement would define what share is yours, and what share belongs to your partner(s). As well as if there are any limitations in place surrounding the sale of an ownership share of a business due to a divorce.
As you can see, determining what percentage of a privately held business is considered marital property can be quite tricky…
Parenting time, child support, and spousal maintenance can all be impacted in a business divorce.
So far I’ve discussed many of the issues you and your divorcing spouse will face that are directly related to divorce with a business involved.
But in addition to the issues of valuations, buyouts, and who gets what share, other indirect issues arise in a business owner divorce process.
How do you handle parenting time?
It’s no secret that a business owner’s schedule can be erratic.
Late-night customer emergencies. Early morning staffing issues. After-hours networking meetings. All of these happen outside of normal business hours.
But how will you be able to commit to a parenting time schedule when your calendar can change at a minute’s notice? Your soon-to-be-ex-spouse may not be so accommodating of your last-minute emergencies and “Sorry, tell the kids I can’t make it” text messages.
Not to mention, you really want to spend time with your kids!
Child support and alimony can be difficult to agree on!
One of the benefits of working for someone else (as an employee) is a steady paycheck.
On the same day of the week or month, a consistent amount of money is received in your paycheck and deposited into your bank account. So you know exactly what you can expect to earn in a given year.
In cases like these, both spouses know how much money is available to support the children, and both households, post-divorce. Which gives them (and me), a clear starting place in support negotiations.
But if you own a business, issues surrounding child support and alimony are far more complex.
First, it’s not uncommon for business owners to forgo a salary for many years. Choosing instead to take money out of the business only when necessary. In turn, it making their earnings unpredictable and inconsistent.
And second, even if you are paying yourself a salary, the amount you take is predicated on the success of your business. If things aren’t going well, you may be forced to take a cut in pay.
But your children and your soon-to-be-ex spouses’ expenses are a constant. They’re counting on receiving a certain level of regular, monthly support. So, any variability in the amount they receive likely won’t work for them.
Shifting the conversation in a more positive direction, if things in your business are going well, not only will you receive your salary, but you may be able to take money out of the business in the form of a bonus. Which couldn’t have been accounted for at the start of your company’s fiscal year.
Do your children and ex-spouse get to share in that, too?
And don’t forget, you’re likely able to run certain expenses through your business like:
Cell phone plans;
Automobile expenses; and
Meals and entertainment
Non-business owners pay these expenses out of their paychecks. So, in a way, your paycheck stretches farther than theirs would.
While this may not be income in the traditional sense, how, if at all, do you account for it when it comes time to negotiate support?
Agreeing on child support and alimony is hard enough. Throw in both the variability in income and difficulty in defining exactly what your income is, and your support negotiations become even harder.
There is more than meets the eye when it comes to divorce with a business involved.
Divorce with a business is not a one-size-fits-all topic and every couple’s situation, circumstances and determining factors are unique.
So coming to a fair agreement with your soon-to-be ex-spouse requires more than just a passing conversation or a wild guess. And as you’re seeing, there’s a lot involved in this highly complex matter.
Divorce and Business Owners: When lawyers get involved, it’s a problem.
Because they don’t know your industry or your business, if you go the divorce lawyer route, your attorneys can drag your divorce proceeding on for years.
Fighting and fighting. Around and around in circles - in a very gray area. All while billing you their outrageous hourly fees.
Making your business asset a liability!
When a judge gets involved, it’s a problem.
And if the issue cannot be resolved between the two of you and your lawyers, your case will go to litigation in court.
There’s something you need to understand here: In litigated divorce proceedings, a judge determines the outcome in court on a case-by-case basis.
Sounds scary, doesn’t it?
Because they’ll dictate the terms of the divorce settlement in court and tell you what you’re going to pay or receive.
And each of you might wind up with a result you don’t think is fair or that doesn’t meet your needs.
That’s why it’s better to negotiate dividing a business in a divorce. And negotiation is exactly what divorce mediation is all about.
In mediation, you both get to decide - and come to an agreement on - an equitable division of the business, out of court. Instead of letting the future of your business be decided by a stranger.
If you're a divorcing business owner, you’ll get the best result by mediating.
Using our extensive financial knowledge of the complex matters surrounding divorce and business owners, we'll work with you and your spouse together to define which part of the business is marital property and which issues are relevant in your divorce matter.
We’ll then actively guide you through your negotiations and present many options to resolve areas of disagreement.
We’ll also make sure your settlement agreement minimizes tax consequences, avoids penalties, and improves cash flow whenever possible.
But we don’t just stop there.
We’ll also help you negotiate a complete agreement that includes all the issues you and your spouse will need to resolve in your divorce including, but not limited to: parenting time, child support, alimony, and all other marital property division (and liabilities).
And since we offer flat-fee mediation services, we have no vested interest in prolonging the conflict because we don’t bill you hourly as a family lawyer would.
Equitable Mediation enables you to get a fair divorce outcome.
Why be forced to accept a settlement created by a family law attorney or judge when you can have a direct say in your financial future instead?
If you want to arrive at an agreement on the division of your business out of court - that’s fair to each of you and doesn’t bankrupt you in the process, mediate your divorce with Equitable Mediation.
If you and your spouse have both agreed to end your marriage and are ready to begin the divorce process, take the next step and book an initial meeting for the two of you.
Joe Dillon, MBA is a professional divorce mediator and founder of Equitable Mediation Services. Joe is passionate about helping couples avoid the destruction of attorney-driven litigation and specializes in helping couples resolve the issues required for divorce -peacefully, fairly and cost-effectively. When he’s not mediating, you can find him exercising, cooking, and watching Cubs baseball.