How to Resolve Business Ownership in Divorce

A business typically provides income for the family and is also considered property, which may be divided between spouses in a divorce. In other words, both spouses may have ownership rights in a family business and are entitled to their share of the “equity” when the marriage ends.

There are a wide variety of closely-held businesses, including professional practices (for example, medical, dental, law and tax) and retail businesses, such as specialty shops, internet businesses and restaurants. While each business will have its own set of problems and complications, there are basically three methods of dealing with a business during divorce.

Co-ownership

With co-ownership, both spouses continue to own the business after the divorce. If spouses remain amicable, it may be possible to work together after a break-up. But this is not for the faint of heart; it will require a solid working relationship or high level of trust in the other’s management skills.  Realistically, continued co-ownership is often a recipe for disaster and not really a viable solution.

Sell the business and divide the profits

The pros of this option are that both spouses may profit from a sale of the business and can use the proceeds to invest in their own business ventures. Plus, spouses can avoid additional financial ties to their ex-spouse. The downside is that it could take a long time to sell and it may need to be significantly “discounted” in order to sell or liquidate.  Also, this business may be the “Golden Goose” which lays the eggs long after the divorce (continued income for the ex-spouse as well as the source of child support, spousal support, property settlement notes, etc) and selling the business may not be the most prudent financial move to either party.

Buy-out the other spouse’s interest

In a buyout, one spouse keeps the business and buys (pays for) the other spouse’s interest. A buyout may be the best option assuming there are sufficient assets to complete the transaction. This can be accomplished if the buying spouse has enough cash or liquid assets available to pay off the selling spouse. Alternatively, the spouses could offset the selling spouse’s portion of the business with other assets such as home equity, retirement assets, real property or other investment securities.  If the business comprises most of the couple’s net worth, the spouses may have to enter into a “property settlement note” or “structured settlement,” which will be paid out over time to the selling spouse. A property settlement note is similar to a note at a bank – it should have a reasonable rate of interest, a definite term and a principal amount.  Also, this “income” is often tax advantaged.

Community versus separate property

In Texas, a business started during the marriage with joint funds is “community property” – meaning it’s owned equally between the spouses (50/50).

A business created before marriage, or founded with “separate property” funds (money earned before the marriage or by gift or inheritance) is a separate property business (owned by one spouse).

The key elements to determine community versus separate property are:

• the date of the marriage and date the business was founded
• the source of funds used to start the business, and
• the financial and labor-related contributions of each spouse to the business during the marriage.

Separate property businesses may (and usually do) have community components that will need to be valued and accounted for. Community interests may derive from:

• joint funds used to expand or invest in the business
• any appreciation in value attributed to joint financial contributions during the marriage, and
• the spouses’ contributions to the business, if those contributions played a role in the operation or growth of the business.

Bottom line – The characterization of a business as community or separate can be very complicated and should be thoroughly reviewed and analyzed from a legal perspective.  In addition to the “characterization” on the business asset, the complex task on “Business Valuation” needs to be addressed with the involvement of experienced and qualified professionals.