Protect your business in divorce
In Texas, when you own a business and are seeking a divorce, court proceedings often get complex. Business ownership can complicate a divorce proceeding because the court seeks to provide a just and right division of property for both parties, which may not necessarily coincide with your views on what an equal division is. A just and right division is determined by the court as the most equitable or fair property division for both parties.
Before you read any further, you should know some basics about Texas property.
There are two types of property categories to be aware of in marital property division: separate and community property.
Separate property is property acquired before your marriage or given to you personally through gift, devise, or descent. Devise or descent is property you inherit from someone. Community property is property acquired during the marriage. Income generated from separate property can actually be viewed as community property, and generally is viewed that way.
Texas is community property state, which means property acquired during the marriage is presumed to be community property. If the property in question, like your business, is separate, you need evidence to show the property is separate, which is called rebutting the presumption of community property.
Is there a way to plan for and protect your business before marriage?
Yes! Signing a premarital or prenuptial agreement is one way to keep your business interest(s) protected. You can also use a partnership, LLC, or other similar agreement to create a business structure that protects your interests in case of divorce. Some people even choose to include divorce provisions in their business agreement when setting up a business. If you do not plan for your business to stay separate property, something as simple as depositing money from your business into a shared bank account makes the money community property because it is viewed as income. The thing to remember is that profits and income you gain during your marriage are community property no matter if the business itself is separate property.
What if I already have a business and just got married?
You can still protect your business. One thing you can do is sign a postnuptial (or postmarital) agreement with your spouse. This type of agreement is similar to a premarital agreement and can have the same types of provisions. It is just signed after the wedding. The goal of a postnuptial agreement is to create a legally binding agreement that divides assets, as well as debt, in case of divorce. But, you should be aware that these are closely reviewed by judges in divorce cases. Postnuptial agreements may be a good way to agree that income generated from separate property, if your business is separate property, will remain separate. You can also use a postnuptial agreement to determine a set amount of money that your spouse will be entitled to in case of divorce. You can tailor the provisions as needed in order to safekeep your business in the event of divorce.
You can also sign an agreement incident to divorce or annulment. If you cannot reach an agreement of a just and right division of property, the court can order you to reach a new agreement, so long as you did not execute a Mediated Settlement Agreement (MSA) that is binding.
How does a court decide what to do with a business?
A court seeks to split all property, including businesses, in a just and right way. In essence, this means that a business, like any other property, must be evaluated to determine whether the business is separate or community property.
So, how does a court determine the value of a business?
A court has to characterize and value a business because it is treated like other assets in the marriage. The court decides whether the business is separate or community property and figures out how much the business is worth. This can be an expensive process because a financial expert has to review the business, including profits, assets, liabilities, projected income, expenses, etc. By conducting this process, the court determines how much of the company or business each spouse is entitled to.
Remember: a just and right division is not necessarily an equal, 50-50 split of the assets.
To figure out what type of property a business is, the business must be characterized. This process is just what it sounds like: figuring out (or characterizing) whether a business is separate or community property. The court uses “clear and convincing” evidence, which is a burden of proof, to determine whether property is separate. As long as you can show the court that the property is yours only in a way that meets the clear and convincing standard, it will not be subject to a division. The clear and convincing standard is in the middle of the burdens of proof spectrum, so it is more than a preponderance (roughly 51 percent) but less than beyond a reasonable doubt. In essence, you need to show that the property is substantially, or more likely than not, separate property versus community property. This process can get complicated. For example, if a spouse owns a business prior to marriage, the business is probably theirs. However, profits received from the business during the marriage, or an increase in value of the business during the marriage, are generally construed as community property.
The court then figures out how much a business is worth through a process called valuation. There are different formulas a court can use to come to a decision on how much a business is worth. Some questions a court may ask are:
- Is the open market price of the business, if sold, the best way to determine the value?
- Are there parts of the business, both tangible (like real estate) and intangible (like intellectual property and debts), that need to be evaluated?
- Is one spouse more involved in the business than the other, and if so, will the loss of some or all of the business for this spouse be detrimental to the company?
What goes into property valuation other than the physical property itself?
Most people think of physical property when they think of a business. A building that houses the company, desks, computers, etc. all come to mind. But, intangible assets, like goodwill, are also a factor in the asset valuation process and can affect the amount or type of assets one spouse can receive.
Goodwill comes in two varieties, enterprise goodwill and personal goodwill. Enterprise goodwill is the business’ ability to attract new customers and retain existing customers for a number of reasons, including location, reputation, skill, etc. Personal goodwill is the ability of one person, in this case one spouse, to bring in new and existing customers because of his or her skills and reputation. Enterprise goodwill belongs to the business and can be used by the court to value the property. Personal goodwill is solely related to the individual and is not used to determine community property.
Who conducts the valuation?
Generally, a CPA who has a special accreditation in Business Valuation or another expert, such as a Certified Business Appraiser, perform the valuation. In every case, the expert needs to be well-versed in Texas divorce cases and law.
So, how does a business get split up?
There are a few ways a business can get divided. One way is that one party gets to retain the business and the other party gets compensated financially. In other words, you buy out your spouse. Generally, people choose this route and allow the spouse that is more involved in the company to keep the business. If you cannot give your spouse an asset that is worth their share as determined by the court, you may be able to set up recurring payments until you have paid your spouse their portion. When a business existed before the marriage, generally the value being determined is the value of the business at the time of marriage. Another option is selling the business and splitting the proceeds from the sale of the business. If the business cannot or should not be given to one party, split, or sold, you can also keep operating the business as joint owners. This option can get complicated and the court often must decide that joint ownership is the right solution. Both spouses must show they will continue to be involved in the business (for the benefit of the business), that the parties can work together, and that both spouses want to keep the business running.
If I have interest in a corporation, will my spouse get it in the divorce?
Maybe. A judge generally cannot take corporate assets, but a judge can give your spouse your shares of corporate stock or interest. You cannot be divested of separate property and profits belonging to the company are a corporate asset, so company property is neither community or separate property.
One area where you may run into issues, however, is if your business adversely affected the community property. Another issue you could run into is if the court cannot separate the spouse from the business, meaning the two are so closely related that they are practically the same entity. In such cases, the court may find a larger award is fair for your spouse. Similarly, if separating a spouse from the business would be fraudulent because of their relatedness, the court may award the other spouse more property.
The court may also award more property to your spouse if your business solely funds your household. Meaning, there is no additional source of income other than the profits from your business to fund living expenses. The court may also treat property as community property if you use corporate or company accounts to take care of household expenses. Basically, if you treat the company like your family’s bank account, the court probably will too.
What should you remember about business ownership and marital property?
Texas is a community property state, so property division can get really tricky during business owner divorce proceedings. You should keep clear records of property you were gifted or property you inherited to be able to show you are the sole owner, or that it is separate property. Do not comingle funds between your personal accounts and your business, unless you are okay with the property being treated as community property if your marriage ends in divorce. Most importantly, a court’s job is to provide a fair division of property for both spouses, even if that means one spouse ends up with a larger share.
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Do you have questions about business owner divorce? If so, call us at (817) 900-3220.