Business in Divorce

Business in divorce

When contemplating divorce, most spouses will think about rental properties, family homes, and financial assets. According to California law, business is also an asset that couples need to deal with during marital distribution. Business distribution has its intricacies, especially when valuing and dividing. So here is what you need to know about business in divorce.

Small Businesses and Professional Practices

Part of the marital dissolution process for spouses is valuing and dividing assets. While some properties like bank accounts are relatively easy to divide, others such as businesses are incredibly complex to value and divide. In most cases valuing a small business in divorce  require the intervention of experts. In finding the value of a business, the experts will evaluate a number of components like accounts receivable, liabilities, fixed assets, and goodwill.

It is important to note that when valuing businesses, accounts receivables are not always included at nominal value. There is always a reduction in bad debts, taxes on collected amount as well as collection costs.  The percentage write off is determined based on expert testimony.

Financial Interests in Small Businesses or Professional Practices

For the court to determine the ownership rights to a business in divorce, it must decide if its a separate property or a marital property. Some of the factors that the court will look at include establishment date of the business, nature of funds used to establish the business, couple’s contribution to the business, and change in the value of the business at the start of marriage and at the time of divorce.

After determining the ownership rights, the court will divide the business in divorce based on the following factors.

(i) Premarital Separate Business in divorce Generally Remains Separate Property 

Generally, a business acquired before marriage always remains the property of one of the spouses. Also, businesses that may be regarded as separate property include:

• Those acquired as a gift by one of the spouses
• Inherited businesses
• Businesses obtained using one spouse’s asserts with intentions of keeping it separate
• Businesses acquired in the name of one spouse and not used for the benefit of the marriage or both spouses

(ii) Transmutation and Other Agreements

Business in divorce can be determined to be marital property based on signed agreements between the spouses or through transmutation. Such agreements include those entered premarital and postmarital.

Discovery, on agreements between spouses always focuses on the formation and language of the agreement and how it affects the business in divorce  in order to establish if there is a transmutation of interest between the spouses.

Another factor considered when looking at spousal agreements is the type of business. If it is a joint venture like multiple shareholder corporations, partnerships, limited liability partnerships (LLPs), or limited liability companies (LLCs), agreements between a spouse with the other participants will also be considered to define valuation. In such a case, discovery will focus on the language of the agreement, agreement interest, ‘out’ spouse’s consent, and prior drafts.

(iii) Effect of Agreements Between Principals of Business or Practice

Agreements on a fixed value of interests between principals of business have been used in the valuation of businesses in divorce. However, these agreements are not always binding even when signed by both parties. Discovery in effect of the accords should focus on the time when the interest was created.

(iv) Pereira or Van Camp Apportionment of Interests

The method of determining the interest of a business in divorce  was set up in the two cases of Pereira v. Pereira (1909) and Van Camp v. Van Camp (1921).

According to these cases, if the value of a business in divorce increases during the time of marriage (period after marriage and before separating), the increase will be apportioned. The apportionment will be based on one of Pereira method or Van Camp approach, or both.

Under Pereira’s approach, the court will award the community a fair share of the increase and give the rest as the spouse’s separate property. The court uses Pereira’s formula when spouse’s time, skill and effort are major factors in growth of business. On the other hand, under Van Camp method, the court, through the help of an expert, will determine the value of the services offered by the community during the time of marriage and apportion it to the community. The rest is allocated as spouse’s separate property. The court uses Van Camp where capital investment was the major factor in the business’s growth.

 

Continuing from the exploration of business assets in divorce, particularly within the context of California law, it’s crucial to delve deeper into the strategies employed for the equitable division of business interests and the considerations that impact these decisions.

Strategies for Dividing Business Interests

When dividing a business in a divorce, several strategies can be employed to reach an equitable solution. These include:

1. Buy-Out: One spouse may buy out the other spouse’s interest in the business. This often requires a precise valuation of the business and available liquidity or financing options to complete the buy-out.
2. Co-Ownership: Some divorcing couples decide to continue co-owning the business after the divorce. This requires a high level of trust and the ability to separate personal issues from business operations. Legal agreements outlining the terms of co-ownership and decision-making are essential.
3. Selling the Business: In some cases, the most straightforward solution is to sell the business and divide the proceeds. This option might be chosen if neither spouse wants to maintain the business or if a buy-out is not financially feasible.
4. Compensation Through Other Assets: If one spouse retains the business, the other might be compensated with an equivalent value in other marital assets, such as real estate, retirement accounts, or cash.

Valuation Challenges

Valuing a business in a divorce is often complex and contentious. Several factors contribute to this complexity:

– Valuation Date: The choice of valuation date can significantly impact the business’s appraised value, especially in rapidly changing markets or industries.
– Method of Valuation: Businesses can be valued based on assets, earnings, market comparables, or a combination of these and other factors. The chosen method can greatly affect the outcome.
– Intangible Assets: Goodwill, brand recognition, and intellectual property are challenging to quantify but can constitute a significant portion of a business’s value.
– Future Earnings: Projections of future earnings and potential growth can be speculative and lead to disagreements.

Legal Considerations and Expert Involvement

The involvement of legal and financial experts is often necessary to navigate the intricacies of valuing and dividing a business in a divorce. This might include:

– Forensic Accountants: To uncover hidden assets, verify financial information, and provide an objective assessment of the business’s value.
– Business Valuation Experts: Specialists who can apply various methodologies to ascertain the fair market value of the business.
– Legal Counsel: Attorneys who can negotiate terms, draft agreements, and represent the client’s interests effectively, especially when dealing with complex assets like businesses.

Tax Implications

Divorcing spouses must also consider the tax implications of dividing a business. The structure of the business (e.g., LLC, S corporation, sole proprietorship) and the method of division can have significant tax consequences for both parties. Tax considerations include capital gains, transfer taxes, and the future tax liability of the business.

Emotional Considerations

Beyond the financial and legal aspects, the division of a business in a divorce can carry significant emotional weight, especially if the business represents years of hard work and dedication. Navigating these emotional waters requires sensitivity and a willingness to seek solutions that respect both parties’ contributions to the business.

Conclusion

The division of business interests in a divorce is a multifaceted issue that requires careful consideration of legal, financial, and emotional factors. With the right support and expertise, divorcing couples can find equitable solutions that allow both parties to move forward. Whether through buy-out, co-ownership, sale, or alternative compensation, the goal is to ensure that the division is fair, takes into account the true value of the business, and addresses the needs and future prospects of each party.

 

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