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Splitting up a business in the event of divorce

Divorce is not a pleasant topic, but unfortunately it can and does happen. Divorce really sucks when it is made unnecessarily expensive, acrimonious, and difficult by spouses fighting over a business. There is another way.

Choosing a Path Forward

Three basic paths for handling a business during divorce are:

1. Both parties retain equity ownership in the business. If both spouses worked in the business prior to divorce, it may be possible to continue a working relationship despite the divorce. Even though the romantic relationship did not work, the business relationship may work. However, where there is rancour, continued joint ownership can be a recipe for strife.

2. Sell the business and divide the profits. This method allows both parties to extract cash. In practice, however, most private businesses cannot be easily sold under duresse for a ‘fair’ price. It can take a long time to find a buyer, and this delay will require one spouse to run the business until it’s sold.

3. One spouse keeps the business and offsets a portion of its value with other assets. This is usually the preferred option, assuming that there are other assets to complete the transaction.

The Legal ProcessThe court and legal advisers will be familiar with the conventional scenario in which one or both spouses are earning salaries. The marital estate may contain fairly liquid investment assets such as stocks or bonds, and there may be an ownership interest in a home. Here, the court can more easily make a decision on how to appropriately allocate the marital assets, while taking spousal support, child support, and related issues into consideration. Things tend to become more complicated when a business interest is involved.

Yours/Mine versus Ours

A business started during marriage with investment from both spouses (financial equity, sweat equity) is often considered part of the marital estate (community property). A business that was already in operation or was begun with separate investment can be more complex to consider. The community interest may involve joint funds used to expand the business and any appreciation attributed to that contribution. If both spouses played a role in the operation, the contribution of each spouse must be considered. Even if no joint funds are contributed, a marital interest may exist and should be reviewed by a legal professional. To determine community property versus separate property, consider these key elements:

l The source of funds for the startup of the business

l The date of the marriage (before or after the start of the business)

l The date of valuationwhich can be either the date of separation, the date of filing, the date of the hearing, or some other agreed-upon date

l The contribution of each spouse to the business

A Cautionary Tale The divergence of the estimated value of the business significantly increases when only one of the spouses is actively involved in the business. Some non-working spouses mistakenly rely on the estimate of the working spouse because of a fear that the cost of a valuation may be prohibitive. The following frequently cited case from Minnesota illustrates the importance of obtaining an independent divorce business valuation.

Debra Sax married Paul Taunton in 1994. Taunton was the owner of a business called Athletic Fitters, Inc. (AFI). Taunton told Sax that the business was worth $6 million and his annual salary was about $300,000.

Sax filed for divorce in 1997. Both parties wanted to divide the marital assets quickly. Sax agreed to a divorce settlement based on what Taunton had told her about the value of the business and his yearly income.

Taunton had underrepresented both the value of the business and his personal income. A few months after the divorce was finalised, Taunton sold AFI for $30 million. A post-divorce investigation revealed that Taunton’s annual income had been about $900,000 in 1994 and $4 million in 1996.

Sax sued Taunton’s attorney, claiming that the attorney’s firm had misrepresented the facts of the case. Legal experts did not expect Sax to win her case since Sax chose not to have an independent divorce business valuation conducted and relied on information provided by Taunton and his attorney.

Three Tips for Success

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Mutual retention. The valuation professional should ideally be mutually retained (hired by both parties). Both parties may choose to share the cost of a joint appraisal, rather than each person retaining his or her own expert. This course of action tends to save time and reduce concerns of bias.

l

Ensure transparency. The valuation professional needs transparency and access to information in order to assist in an efficient and effective manner. The divorcing parties as well as their legal representatives should ensure that the business appraiser receives a complete perspective of the business’s operations and financial history.

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Appropriate use of valuation methodology. The valuation professional must use methodology appropriate to the context of the valuation, the purpose of the valuation, and the unique attributes of the business. Valuation methods used when estimating the value of a business for sale may be inappropriate in the context of divorce or litigation.

While divorce is never easy (especially when a business is at stake), it can be made less difficult when the parties involved take a common-sense approach to the separation of business assets.

Note: This article is not intended to provide legal advice. We strongly recommend that you obtain assistance from a qualified legal professional.

Divorce: Dividing a business when a couple breaks up can be a complex and sometimes acrimonious process

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Published September 06, 2011 at 10:19 am (Updated September 06, 2011 at 10:18 am)

Splitting up a business in the event of divorce

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