You’ve poured your heart and soul into your business. You’re reaping the rewards of all your hard work and sacrifice. Unfortunately, you’re also heading for a divorce, and your spouse has eyes on your beloved company. What can you do to protect this important asset?
This is a question we’re asked all the time in our divorce practice. But for many of our clients, it’s already too late to maximize protection. That’s because the best time to divorce-proof your business is before you take that trip down the aisle. While you’re still single, a few decisive steps can establish your separate ownership of your business and remove it from the divorce discussion.
Simple Steps to Designate Your Business as Separate, Not Marital, Property
Under New York’s equitable distribution law, spouses keep their separate property and divide their marital property. Your business would be separate property if:
- You started it before you got married, or
- You started it during the marriage using only separate funds, and
- You maintained the business as a separate asset throughout the marriage
In many cases, one spouse will own a small business but treat it too much like a family business. Over time it becomes a marital asset through a process called commingling. So, your first task is establishing that your business is separate property. You can do this by:
- Incorporating — If you are running your business as a sole proprietorship, there is no clear separation between your business and your personal finances. When you’re married, those personal finances are marital property. For example, with a sole proprietorship, you can report business income on your personal income tax return. If you file jointly with your spouse, you’re practically admitting to co-ownership. By incorporating, you create a separate entity. The papers of incorporation will state that you are the owner.
- Executing a marital agreement — Martial contracts, either prenuptial or postnuptial, establish property rights. You can clearly state that your business is separate property and not part of the marital estate.
- Placing the business in a trust — A trust is a separate entity you create to own the business. You can do this before your marriage, or while you are married as long as you haven’t been treating it as a marital asset. But be careful. The closer to the divorce you do this, the more it will resemble a fraudulent transfer. The court can dissolve the trust and toss the business back into the marital pot.
Once you’ve established that the business is separate, you have to keep it that way. Commingling the business with your marital estate will create an equitable interest for your spouse. To avoid commingling, you should:
- Pay yourself at market rate — If you are knocking yourself out at subsistence wages, so you can put money back into growing your business, that’s commendable. But your spouse will say you shortchanged the household. The resources you recycled were rightfully household funds, so your spouse now has an ownership interest.
- Don’t accept free help from your spouse — Family businesses are often an “all hands on deck” operation. But allowing your spouse to work uncompensated or below market rate creates an equity interest. Your spouse may be able to make a substantial contribution to your business's success. Just be careful. Pay market rate for those services, or don’t let your spouse get involved.
- Don’t fund the business with marital assets — Every business needs an occasional cash infusion, and it’s often easier to raid your savings or take out a second mortgage than to get a business line of credit. If you must use marital funds, be sure to draw up a loan agreement with a schedule for repayment and stick to the terms.
Of course, not every small business owner operates with an eye towards divorce. Many clients come to us concerned about businesses that have not been divorce proofed. What can be done now to ensure they hold onto their enterprise? Here are a couple of strategies:
- Get a favorable valuation — If the business goes into the marital estate, your chances of holding onto it, intact, are better if you get a low estimate of its value. It becomes easier to offset the award of the business to you with other assets in the marital estate going to your spouse.
- Execute a buy/sell agreement — If your business is a partnership, you can execute an agreement barring your spouse from assuming a leadership role in the event of a divorce. You may have to give your ex a share of the profits, but you can at least retain control.
An important point to remember is that New York law is equitable distribution, not community property. Spouses don’t automatically get a 50-50 split of marital assets. Courts divide assets in a fair, but not necessarily equal manner. If you have been the driving force behind your business and have built it up with your talent, industry, and vision, then you deserve the lion’s share of the ownership. At this point, what you need is an experienced divorce lawyer who is ready to fight for your right to retain the business you created.