November 22, 2017 Practice Points

Divorce and the Closely Held Business: Myths and Reality Checks

By Lauren Sorrentino

Closely held businesses pose unique challenges for divorcing couples. In many instances, spouses may work side-by-side in the business—whether one or both hold ownership interest. Or one spouse may focus on maintaining the home, child-rearing, and other domestic chores, while the other spouse focuses on his or her entrepreneurial venture. Additionally, and more often than not, extended family members may be partners, members or shareholders in the business, adding to the complexity and, potentially, the emotional stress of the litigation.

While each divorce and business are unique, a basic understanding of the intersection between the two may help limit the complexities and/or emotional stress that can be experienced when dealing with this type of asset. Below are a few common misconceptions spouses typically have regarding their rights and/or obligations with respect to closely held businesses.

Myth: I am the only one involved in the business and my spouse has no ownership interest, so the business is off limits in divorce.

Reality Check: Most states are “title-blind” in defining marital or community property subject to division or distribution in divorce. Even though one spouse has a titled legal interest in the entity, the other may still have an equitable interest in the business’s value.

Myth: My spouse is going to “get” my business or I am going to have to sell my business.

Reality Check: Courts generally want to disentangle spouses. If a spouse has no knowledge of the business and no existing ownership interest, he or she will not suddenly receive an interest. Courts typically recognize the sale of a closely held business is neither easy nor optimal. So, they may attempt to offset the value of a business with other assets or, in cases of illiquidity, they may use secured payment streams and/or an increase the duration or amount of alimony to compensate the non-owner spouse.

Where both spouses have ownership interests, and both are actively involved in running the business (and this is key), if practical, a division of the business may be an option, particularly if there are franchises or services with multiple locations. Less frequently, if the parties are amicable, they may be able to continue to stay in business together with tight parameters for salaries, distributions, capital expenditures, and general operations.

Myth: I’m just a minority shareholder; my interest is not transferable and I do not have access to any information.

Reality Check: Even minority shareholders are entitled to financial information regarding their business interests. In fact, many states have specific laws providing for the release of such information as part of their statutes applicable to corporations, partnerships, and limited liability companies. Contesting the release of information regarding basic revenue, expenses, profits, losses, assets, debts, and taxes is typically not worthwhile in a divorce case, and may be counterproductive or escalate mistrust between the parties. That being said, it is reasonable for the spouse involved in the business to request a confidentiality agreement to protect competitive or other sensitive information and ensure that use of all information turned over in the divorce process is limited to the divorce litigation.

Myth: My shareholder, partnership, buy/sell, or operating agreement determines the value of my share of the business. There is no need for an expert or a business appraisal.

Reality Check: While such agreements contain formulas for valuing shares or interests in the event of a buy-out, depending on the jurisdiction and circumstances surrounding the execution of the agreement, these formulas are not dispositive of value in a divorce. Counsel should obtain and review these agreements; however, counsel should also be aware that in many states if the spouse without the ownership interest did not sign off on the agreement, he or she is not bound by the value. Even if he or she did consent to the agreement, if it was done without a financial disclosure and independent counsel, it’s possible the content will not govern value in the divorce action.

Myth: My spouse makes a very significant income; therefore his or her business must be very valuable.

Reality Check: A possibility but not axiomatic. Particularly with professional practices, much of the business’s value is tied up in the individual professional. This type of personal goodwill, while valuable, is not always distributable in divorce cases. Different jurisdictions approach the issue of goodwill differently; however, the majority of states generally exclude personal goodwill from marital or community property.

Moreover, if an income stream is used to determine support or alimony, capitalizing the same stream of income to value the business may be considered a “double dip” in some cases.

Business owners should consider the potential value of a pre-nuptial or post-nuptial agreement as a way to reduce or eliminate some of the difficult issues posed by divorce. They should also seek qualified counsel familiar these unique issues.

Lauren Sorrentino is a member of Norris, McLaughlin & Marcus, P.A., in its Allentown, PA office.


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