While no one anticipates the end of a marriage, sometimes divorce happens. It can be emotionally devastating, and even more complicated if you are a business owner.
When a divorce occurs in the absence of a prenuptial agreement, your business interest, or at least some of its value, may be considered a marital asset. This can lead to challenges to valuing and dividing the family’s assets and liabilities.
Here are some options to protect your family business if you don’t have prenups in place. Of course, it’s always best to consult with an experienced attorney and CPA who can advise you on the best moves for your specific circumstances.
Postnuptial Agreements
Postnuptial agreements function similarly to prenuptial agreements except they are signed after marriage. In a postnuptial agreement, similar to a prenuptial agreement, both partners must agree to the terms. These agreements can address how business assets, personal assets and debts will be distributed, designate ownership rights, determine the valuation of the business, and can include additional clauses to safeguard the family business should the marriage end.
However, postnuptial agreements require “consideration” for entering into them. The consideration can take various forms, including money, property, services or any other valuable benefits. Often, postnuptial agreements are entered into when there is a change in circumstances, positive or negative.
Buy-Sell Agreements
Buy-sell agreements and redemption agreements can help protect the stability of a family-owned business. This contract is a legally binding contract between family business co-owners and their business to address various scenarios, such as the death or disability of a co-owner, retirement, divorce and voluntary or involuntary departures from the business.
The Buy-Sell Agreement can function as a stand-alone contract or be incorporated as a provision in the partnership, shareholder or operating agreements, as applicable. Its purpose is to protect the business interests of the other co-owners in the event that one of the owners experiences a divorce, ensuring control and ownership remains within the family business.
Regarding divorce, if the business-owner spouse wants to retain control of the business, while the non-owner spouse wants to cash out his/her “share” of the business value, the business-owner spouse may choose to “buy out” the non-owner’s interest in the business.
Attorney Richard Schloss with Dawda Mann, PLC in Bloomfield Hills, said, “many times the sales price for the business owner is discounted for an event of a divorce. For example, in a case where there are multiple owners of the business, and the spouse is not an owner, the buy-sell agreement may provide for the buyout of the owner spouse’s interest at a discounted value over time. This provision aims to put a chilling effect on the non-owner spouse’s attempt to maximize value for the business interest. I recommend that when there is a non-owner spouse, the non-owner spouse agrees to the terms of the buy-sell agreement to avoid conflict if a divorce occurs.”
In addition, buy-sell agreements can protect the family business by prohibiting owners from selling to people outside the family. Having such an agreement in place can facilitate a smooth transition without disrupting business operations.
Additional steps and tips to safeguard your family business and your own interests during a divorce include:
- Clear Business Ownership Documentation – maintain meticulous records to ensure that all documents designate the sole owners of the family business and the business’s ownership structure by clearly outlining each family member’s role, shares, and responsibilities within the business. Having well-documented ownership agreements can help prevent disputes during divorce proceedings.
- Separate Business and Personal Expenses – keep detailed documents that state where the capital came from to start your business and capital used for business expenses -whether it came from your own (pre-marital) assets or marital assets. Take care not to commingle your personal and business assets and expenses. This can reduce financial scrutiny during divorce and help to keep IRS out of your hair.
- Avoid Using Marital Funds – using marital funds can make a pre-owned family business, or a portion of it, a marital asset instead of a separate asset.
- Avoid Spousal Contributions to the Business – if both spouses contribute to the business in some way (the non-owner spouse participates in operations or takes on an executive role), a pre-owned family business can become a marital asset. To avoid this risk, consider whether a spouse should participate in the business at all. However, if your spouse does work for the family business, pay the spouse a fair market rate for any work as an employee. Also, you can create a spousal employment contract that clearly defines their role and responsibilities.
- Pay Yourself a Reasonable Salary – frequently, business owners pay themselves an income below the fair market standard in order to reinvest the amount back into the business. An ex-spouse may claim he or she is entitled to more money or a larger share of the business because potential earnings went back into the business rather than the household. Therefore, a business owner should pay themselves a salary based on fair market value for the line of work and type of business they run to avoid such a claim and demonstrate a clear line between family business assets and personal assets.
These strategies highlight the importance of proactive planning and having clear, accurate documentation. Consulting with legal experts and CPAs is crucial to tailor these strategies to your unique family business situation. Implementing these strategies can help protect both the family business legacy and ensure the family business continues smoothly without disruption even in the event of a divorce.
Ursula Scroggs, CPA, is managing director at DKSS CPAs + Advisors, with offices in Troy and St. Clair Shores, Michigan. Jean Stenger, CPA, is director of operations for DKSS.
