Your Business and the Divorce Process
Jay A. Frank
Your business is an asset and is dealt with in the divorce process in the same way as an account, an automobile, or any other asset. The purpose of this article is to provide a summary of some of the issues that might be involved when the divorce process and your business collide head on.
Initially, it is important to understand the difference between marital and non-marital property. Assets that are acquired during the marriage are, with certain exceptions, considered to be marital property. As marital property, they constitute part of the marital estate, which is divided between the spouses in a divorce case.
On the other hand, assets acquired prior to the marriage are non-marital property belonging to the acquiring spouse. As non-marital property, these assets are not divided between the spouses during the divorce case but are awarded to the spouse who owns them.
With this background, let’s first look at a business acquired by one of the spouses before the marriage. This will be non-marital property, and will be assigned to the spouse owning the business. The other spouse will have no interest whatsoever in the business. This is not the end of the story, however, as other issues can surface.
If, during the course of the marriage, the business owner transfers to his or her spouse an interest in the business, then that interest will no longer be non-marital property of the first spouse. If the interest is purchased, it will be the other spouse’s marital property; if the interest is a gift, it may be the other spouse’s non-marital property. In any event, the business is no longer entirely the non-marital property of the first spouse.
A particularly difficult issue arises when a non-marital business is expanded during the course of the marriage. This can occur when the non-marital business purchases additional outlets, or purchases the assets of another business, or just generally expands its operations. While the court cases in this area are not clear, the source of the funds used to expand the business is important. If marital funds or credit are involved, then the expanded portion of the business may be viewed as being marital in nature.
The compensation that you earn from your non-marital business is considered to be marital property if you work in the business. Going a step further, even retained earnings can be considered marital property under certain circumstances where you have control of the business. On the other hand, dividends that you receive are generally classified as non-marital property.
If your spouse works in the business, you may wonder whether you can fire him or her when the divorce case is filed. After all, you may feel at that point that he or she is a “spy” in your business. Generally, if the other spouse has an interest in the business, or is an officer or director, and if the other spouse has not disrupted the business or otherwise acted inappropriately at the business, the other spouse will be allowed to stay during the course of the divorce case. If the other spouse does not have an interest in the business, or has been disruptive, then in many cases the other spouse’s employment can be terminated and he or she can be excluded from the business.
Now, we turn our attention to a business that was acquired during the marriage. Again, this is marital property and is divided, along with all the other marital property, as the court sees fit. However, a business is rarely actually divided up but, instead, it is generally awarded to one of the spouses with the other spouse receiving an offsetting award of equally valued property.
This raises the issue of how a business is valued. The process can be detailed and expensive.Typically, each side will hire a business evaluator who is a professional, similar to a CPA, and who is skilled in determining the value of businesses. The evaluator will review three to five years of financial records (income tax returns, balance sheets, profit and loss statements, checking account records, and the like). A review is made as to the general conditions of the industry and the competitive advantage that the business enjoys in the industry. Buy-sell agreements and similar agreements that provide a formula to valuing the business will also be considered. This information is used to calculate the value of the business based on one or more of several standard approaches. It is not unusual to find a wide disparity in the values by the respective experts, with the owner’s expert arguing for a low value and the other spouse’s expert arguing for a high value.
Even where the business was acquired prior to the marriage and is non-marital in nature, it will probably be valued. This is because the court considers the value of the non-marital property held by each spouse as a factor in dividing the marital property between the parties.
Obtaining legal advice is always advisable when purchasing a business, when expanding an existing business, when structuring a compensation package, when involving your spouse in the business, or when otherwise making changes to the business. You should know the consequences of your actions in advance.
* * * *
Jay A. Frank is a matrimonial practitioner in Chicago, Illinois with over 40 years of experience. He has been selected as one of the top family law attorneys in Illinois.