When meeting with clients who own small businesses and are also married, I always pose the question to them, “what will happen to your business in the event of divorce?” The alarming number of responses demonstrate a lack of reliability in predicting the outcome of divorce. In fact, the majority of business owners who have taken the initiative to protect their businesses through shareholder and operating agreements are surprised to learn those same agreements provide little to no protection from a future ex-spouse. While operating agreements are one tool for the savvy business owner to protect their investment of time and capital in the business, it is just one piece to an overall comprehensive puzzle which when assembled properly provides owners with the greatest security and predictability. The following five strategies should be considered by every business owner to prepare for both marriage and divorce.
1. Marital Agreements
A prenuptial or postnuptial agreement can be an effective tool in limiting claims by outside creditors against your business, which unfortunately can include a future ex-spouse. Such an agreement if executed properly can remove your business from the pool of marital assets subject to equitable distribution in the event of divorce and preserve it as a separate spouse asset. These agreements, if not executed in exact conformity with state law could be thrown out by a court and lead to devastating consequences. It is important to note that creditors of your spouse may reach marital property, which can include your business if not effectively maintained as separate property.
2. Operating Agreement
Tailored shareholder or partnership agreements provide additional protection by restricting the ability to transfer equity interests to outsiders of the business. Some of these provisions may include a buy-sell agreement, automatic non-voting conversion for any involuntarily transferred interest, and anti-assignment provisions. Additionally, such provisions allow business owners to maintain control of how an interest in their business will be valuated, something extremely difficult given the lack of comparable sales for closely held companies. The key here is to avoid boilerplate-default provisions and to instead employ customized triggering events while preserving the right to decide the consequences of such events.
3. Separate Means Separate
Always keep your business objectively separate from your family. Business owners are often tempted to borrow from their personal savings to float business operations or purchases. The commingling of such resources, increases the likelihood that your business will someday find itself labeled as a marital asset subject to claims by an ex-spouse. This also means your spouse or future ex-spouse should not have any involvement in operating the business. The greater a spouse’s involvement is with the business, the more ammunition their future divorce lawyer will have in arguing that spouse’s contribution to the business’s growth entitles them to profit from such growth.
4. Pay Yourself a Good Salary
Often as business owners struggle to grow their business they sacrifice income by reinvesting profits into the business. This typically comes at the expense of limiting family resources but may also be seen as a retirement investment if the business were later sold. By paying yourself a justifiable salary you separate yourself from the business by positioning it as your employer and you also prevent a divorce lawyer from later arguing your business was a spousal retirement vehicle, properly treated as a marital asset.
5. Negotiate Effectively
If it turns out that the division of marital assets does not satisfy an equitable distribution, then you should negotiate effectively to avoid a court from invading your business. A typical solution involves “buying out” the ex-spouse rather than give up ownership or even worse have the business subjected to a forced sale. A valuable technique utilizes long-term periodic payments to an ex-spouse to avoid the devastating effects of a lump sum on business operations. These payments could come from the business’s cash flow, a bank loan, or even a whole-life insurance policy that builds cash value and can be liquidated to provide buy-out funds.
While these five strategies are extremely effective in protecting your business in the event of a divorce, if not properly structured and executed you and your business will be left completely exposed. The business attorneys at Rowe Law Group employ a comprehensive and tailored solution to clients seeking to protect their businesses, utilizing the strategies addressed above coupled with trusts and other long term estate planning devices.