Divorce requires a detailed valuation of all of your assets, followed by a comprehensive division of the assets. Marital assets are divided in a way that is fair but necessarily equal because New York state uses the equitable distribution method of asset division. When you and your spouse own a business as one of your marital assets, division can be complex. Often, one spouse must buy the other out of a company that is co-owned.
Before a business can be divided in a divorce, the business must be valued. Business valuation is a complex process. It is essential that your attorney works with another skilled professional, such as a certified valuation analyst, who understands your specific industry and can compute a fair valuation. The valuation process is crucial because a high valuation means there is more to possibly offset or buy out, whereas a lower valuation means less offset or buy out. The valuation of the business may inform your decision as to how to proceed with ownership post-divorce.
Choices for Handling Business Ownership after Divorce
When you and your spouse co-own a business (or a business is a marital asset), it can be challenging to find a way to fairly divide the business in the divorce. There are a few different ways to handle ownership moving forward:
- One spouse will become the sole owner of the business, or if there are other partners, will buy the other spouse out of their interest
- The spouses will continue to co-own the business, but one will become a silent partner who is not active in management
- The spouses will continue to co-own and co-manage the business as a team
- A phased buyout will occur with one spouse transitioning out of the business as liquidity becomes available
- The spouses will sell the business
This decision must be made by considering a variety of factors. First, does the couple have enough assets so that one spouse can be bought out of their portion of the business? In most high net worth divorces, the answer to this is yes. If that is not the case, the business may need to be sold.
Another consideration is how well the spouses can communicate and will be able to continue to work together as business partners. Some couples are able to do this successfully, but it is not a choice that works for everyone. If the couple is considering selling the business, the question is what is the market value of the business at that point in time and whether it is, in fact, a smart time to sell. Both parties can lose out if a sale is forced a time when the business can't be sold for a prime value.
Options for Offsetting a Business
If the decision is made that one spouse will buy the other spouse's interest in the business, this can be accomplished in a variety of ways. Obviously, an all-cash buyout is a simple solution, liquidity can be a problem for a multimillion-dollar business. In those circumstances, then the solution is to create a balance sheet of sorts for the entire divorce. The spouse who is giving up their interest in the business can then be compensated by receiving other marital property pieces, or even, if necessary, the other spouse's separate property. The selling spouse could receive:
- Real property, including homes or vacation homes or investment property
- Retirement assets such as 401Ks or IRAs
- Investments such as stocks, bonds, or mutual funds
- Other businesses
Leveraging a Buyout
If there are not enough assets to offset the transfer of business ownership, the business itself may need to be leveraged to finance a buyout. A business that carries few debts is in the position to take on debt to buy out the interest of one spouse. It may be necessary to reorganize the business to afford a buyout. Still, the complexity of that can be offset by the importance of ending the partnership at the same time the marriage ends. Continuing to own the company or business together may simply not be feasible because of the state of the couple's relationship.
Managing a Phased Buyout
A phased buyout may be necessary to allow the time necessary to reorganize the business so that the buyout can be financed. If the business has a lot of debt, it may be necessary to proceed with a phased buyout so that the business has time to appreciate it. The selling spouse gives up day-to-day control over the company during the buyout period and is not an active member of the partnership during this phase.
A phased buyout should include a put right so the selling spouse has the option to demand a buyout at a specified time in the future. The put right is optional, which means it's up to the selling spouse to decide if they want to trigger it. In return, however, the buying spouse has a redemption right, to, in essence, force the sale at the predetermined date.
During the phased buyout term, the selling spouse should be entitled to transparency, so that they can monitor the business activity through mandatory audits. In addition to transparency, specific covenants are created to protect the selling spouse, ensuring that the business cannot be sold, cannot take on too much debt, and that the buying spouse cannot increase their own compensation during the buyout period. The goal is to maintain the business's value so that the value remains high at the final buyout.
Negotiating a Valuation for a Buyout
As noted above, determining a valuation for the business is a crucial part of the division process. When one spouse is being bought out of a business outright, the couple must negotiate the valuation during the divorce, which can be an extremely contentious process. However, if a phased buyout is agreed upon, the valuation process is delayed. Generally, however, the divorce decree will contain the valuation formula that will be used. Negotiating this can be challenging, but the formula itself is not used until the buyout actually occurs when tempers have likely calmed, and negotiation is easier to achieve.
A business buyout as part of a divorce property settlement or distribution must be handled with careful thought and planning. It's essential to work with an attorney who has years of experience making smart decisions for clients who can protect your interests.