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Family businesses play an essential role in US economic development as they comprise a significant segment of the workforce (78% of all new jobs).
Statistics show that about 20% of all small businesses nationwide are family-owned. However, according to research conducted by SCORE, a nonprofit organization dedicated to helping small businesses by providing business mentoring and expert support, “Only 30% of family businesses survive the transition from first to second-generation ownership. And even fewer (12%) from second to third-generation ownership.”
Divorce is one of the most common reasons for such disappointing dynamics, but is closing a business inevitable in such a situation?
Uncontested Divorce as a Key to Equitable Settlement
A contested divorce with traditional litigation, numerous hearings, and attorneys’ hourly fees is always costly. So, any couple running a small business would be happy to reinvest this money instead. Besides, long-drawn conflicts between two owners cannot be good for business.
Contrary to popular belief, an uncontested divorce does not require the spouses to be friends. They just settle their differences out-of-court (using lawyers and other experts, if needed) and can reach a more favorable settlement than the court may decide following the equitable distribution rules or community property model.
Bob Butterworth, CEO at СompleteСase divorce service, says:
“Almost half of all marriages end in divorce, and that is a fact for now. Still, divorce may destroy a joint venture, or it may not affect it at all. It all depends on the particular couple. We suppose the spouses may choose the best solution independently if they do not contest the case. CompleteCase helps people get all the required divorce forms completed online and, if needed, contacts the best-trusted lawyers. We believe that uncontested divorce is the best for all who are ready to negotiate, regardless of whether the spouses have minor children or jointly owned property, so we try to provide comprehensive assistance.”
How a Business Can be Handled
Thus, if the spouses want to divide the property avoiding litigation, they have to take similar first steps as the judge does in a divorce proceeding. This typically implies determining which property is marital and separate, following the laws of a particular state, calculating a property’s value, and deciding who gets what.
Determining a business’s value is more challenging than, for example, real estate, as it requires calculating not only tangible assets. Each spouse’s loans, mortgages, bonds, warranties, deferred revenues, etc., should also be taken into account, and each spouse’s interest, which has its value as well, etc.
However, if the spouses still want to value and divide their small business out-of-court, they can consider the following options to calculate the value of a venture and distribute the shares equitably.
- Dissolve the business
By terminating the partnership, neither party is responsible for the former spouse’s liabilities /debts, and neither party is entitled to enter into any transaction on behalf of the partnership. This deal proclaims the couple’s initial business partnership invalid.
- Sell the business
Chris Porteous, co-founder and CEO at Framestr, says, “As drastic as it sounds, this may be the ultimate solution. If due to stock distribution, your former spouse is now involved in the business, and this working relationship is untenable, the only option is to bail out.”
Thus, the former partners will sever all financial ties forever. Besides, if the couple sells their business, it automatically obtains the specific cash value. It becomes easier to divide the earnings equally, and the ex-spouses can bankroll their new business projects.
However, the parties should recognize that it is hard to predict how long selling the business may take. And, if you are satisfied with how good your business is, it may be hard to say goodbye to it.
- Buy out the spouse’s interest
If one of the spouses wants to continue the particular business despite everything, buying out the former spouse’s interest can be a solution.
Thus, the party who wants to continue to run the business independently pays their ex-partner the appropriate amount of money. Another option is to compensate for their part of the business with other assets, including securities (which is more favorable as there are no considerable tax liabilities), IRAs, or 401(k) plan assets.
If the spouses didn’t take precautions, like drawing up a prenup or postnup agreement, separating their finances, or, for example, putting the business into a trust before the breakup, the options above are among the most common. However, whether the parties will sell the business, buy the other’s share, etc., calculating the small business’s selling price is an essential part of the process.
Calculating the Company’s Value
At this stage, the spouses are highly recommended to hire external experts, regardless of whether they hire a lawyer or arrange a do-it-yourself divorce. The specialists who can help determine the value of a jointly-owned business in a divorce are certified public accountants (CPAs) accredited in business valuation, business appraisers, tax accountants, financial advisors, SMSF specialists, etc.
The critical points of business valuation in divorce include:
- Analyzing the assets, tax, and financial documents
The rigorous analysis of all assets, including the values of the tangible and intangible property and the liabilities of the business, provides the foundation for business valuation.
Tangible property includes equipment, inventory, tools, accessories, and other material stuff the company utilizes.
Trademarks, patents, copyrights, software, etc., are intangible property, implying anything that makes the business unique, helping it succeed and make money.
Liabilities of the business include anything associated with costs, like credits, employees’ salary, loans, and other expenses that may produce the business’s debt.
- Calculating the profit
To calculate the company’s net profit, first, you need to find out the company’s total profit from the sale of products/services and income not related to the main activity, and then – deduct from this amount all associated costs necessary to generate revenue. These costs may include obligations, tax payments, equipment maintenance, rent, etc.
Usually, the company’s net profit is determined for particular periods: net profit per year, per quarter of the year, per month, or even per week, depending on the business’s specifics.
- Application of one of the business valuation formulas
There are many different approaches that experts use to determine the value of a business. The two most common are called “the book value method” and the market approach to measuring a business’s worth.
The book value method calculates the business’s value at a given moment based on the balance sheet. Thus, the balance sheet helps estimate the value of the equity (i.e., a firm’s total assets minus its total liabilities), and this value represents the business’s worth.
The market value business valuation formula considers the probable cost, which would be paid for the business by the potential buyer by comparing it to similar companies that have sold.
To use this approach, one should analyze the business’s income over several years, trace the trends in gained profit, and predict what may happen to the value of its assets over the next years.
Unfortunately, not every marriage has a fairytale ending. And when the spouses file for divorce, the family business gets dragged into the settlement agreement.
It would be best if the spouses protect themselves and their business interests by preparing in advance. Prenups or postnuptial agreements are the best mutually beneficial options, along with separating personal and business finances. The spouses may also consider putting the company into a trust or taking out a whole life insurance policy.
Yet, if the couple is dealing with the divorce here and now, there are still things they can do besides litigation: from selling the business to making a binding agreement to continuing the business with the ex-spouse.
