How Divorce Can Affect Your Business

By: Michael Safren, Esq.

Business owners are realists and the unfortunate reality is that approximately half of all marriages end in divorce.  Divorce can affect nearly every area of your life.  As part of the divorce, known as a dissolution of marriage, here in Washington, the couple’s assets will be divided and ownership interests will be assigned to each former spouse.  These assets can include the business that you founded, operated, and have grown over the years. 

One question many small business owners have is how the business will be treated during divorce proceedings.  Nine states, including Washington, have community property laws that dictate all assets accumulated by the couple during the marriage are community property and thus subject to an equitable division between the former spouses.  There are some exceptions:

• Gift, bequests and inheritances:  Any gifts, bequests or inheritances one party receives from a third party, which are kept in separate title, are not considered marital assets.  However, any increase in value during the marriage is considered marital.
• Acquired pre-marriage:  An asset owned prior to marriage, which is kept in separate title, is not considered marital.  However, once again, any increase in value during the marriage is marital.
• Acquired post-separation:  Any asset acquired after separation with non-marital funds is not marital.
• Protected by a prenuptial agreement:  All assets acquired before or in some cases during a marriage can be protected by a well-drafted prenuptial agreement.

However, if you are not careful with your business during your marriage, you could lose any protection these exceptions provide and put your entire business at risk.

How can you protect your business?

Making sure your business is property formed and maintained is one of the most important steps you can take to protect your business.  Forming an LLC, or other appropriate legal entity structure, not only protects your personal assets from your business liabilities, but the entity can also hold the property for the business – like a company car or any real estate your business owns.  While your ownership interest in the business may be marital property, creating a formal structure helps prevent individual assets owned by the business from being subject to division in the divorce process.

Protecting your business – before you get married

If you started your business before you were married, only the increased value as a result of the  growth of the business during the time of the marriage will be considered community property.  Income coming from separate property, such as rent from a separate property house, remains separate property, unless comingled with community assets.  However, income derived from your spouse’s labor and efforts during a marriage is community property.

Sign a prenuptial agreement.  Discussing the ownership and upkeep of your business before you get married can help limit problems that may arise down the line.  A well-drafted prenuptial agreement can outline the scope of the business and determine what parts of the business will be considered community property and what will be separate property.  Both parties should get the assistance of an attorney and detail all of the business’s assets.  A prenuptial agreement is not fool-proof but it does add an extra layer of protection for your business.

Protecting your business – while you are married

Sign a post-nuptial agreement.  A post-nuptial agreement is similar to a prenuptial agreement except that it is signed after you are married.  Although some Courts have rejected post-nuptial agreements, a properly drafted post-nuptial agreement can help you protect your business from being treated as an asset of the marital community and subject to division.  Further, discussing the ownership and upkeep of your business with your spouse can help limit problems down the road.

Keep your personal and business expenses separate.  Keep good records of all of your business expenses.  Refrain from using marital assets to grow the business.  This includes joint credit cards or even taking a loan from your retirement account (a marital asset) to fund the business.

Keep your spouse out of the business.  If your spouse is employed by the business or helps out in any way, they may be entitled to a significant percentage of the business if you get divorced.  The more involved your spouse is in running the business, the greater that percentage can be.

Pay yourself a competitive salary.  Many business owners do not take much salary from their business and instead reinvest all the profits back into the business.  But if you get divorced, your spouse could argue that they did not derive the full benefits of the business during your marriage and so a judge could find that they are entitled to a larger percentage of the business after the divorce.

Create a buy-sell agreement for your business.  Buy-sell agreements are another way to protect your business.  This agreement details what happens to a business should the ownership change.  Besides protecting your business from situations where your partner dies or when the business is sold, it also protects you in the event of divorce.  The agreement might limit a spouse’s ability to acquire ownership, deprive a divorcing spouse of voting rights, or give you or other partners the right to buy at a low, preset price aside from any interest awarded to the former spouse.  A good lawyer with experience in business law can help draft this type of agreement.

Protecting Your Business – After Divorce

Get a good valuation of your business.  A business valuation determines the value of the business for property division purposes.  As estates are divided during a divorce, knowing the value of a business (if it is considered marital property) is critical for the division process.

Pay off your former spouse.  In most cases, the court will not force liquidation (or sale) of the business.  The court will most likely want the business to survive the divorce so instead of forcing the liquidation of the business, the court may decide to have the owner-spouse pay out the value of the business to the non-owner spouse.  You may need to sacrifice other marital assets, like the family home or retirement accounts, to create an event split of assets with your former spouse, or you may be able to make the payments to your former spouse over-time from the future profits of the business.

Protecting your business

No matter what steps your take before, during or after your marriage, the court will likely consider any growth in your business as martial property and will want to ensure that your former spouse received some benefit from that growth.  However, by taking some important steps, you can protect your business and ensure that you retain control over the business, even if you experience a dissolution of marriage.  Ensuring that your business is properly formed, run, and protected from life’s uncertainties is just one of the ways that an experienced business attorney can help you.  If you are a small business owner and want to make sure that your business is protected, Contact Us.

Michael Safren is a Partner at The Law Offices of Jenny Ling, PLLC.  His practice focuses on business, real estate, probate, and civil litigation.