How to Divorce-Proof Your Company
It can happen to the best of entrepreneurs. While a new business owner is putting in long hours to build a business, a marriage can fray. The next thing the owner knows, his or her spouse may be filing for divorce.
This scenario is all too common. Forty percent to 50 percent of all first marriages in the U.S. end in divorce, according to a 2010 report by the National Marriage Project at the University of Virginia. The divorce rate for second marriages is even higher.
For those whose marriage is in trouble or who are about to begin a divorce, a few strategies can help preserve a business. Once the divorce proceedings start, entrepreneurs won't likely be able to implement some other legal maneuvers that, if accomplished in happier times, could keep their business from landing in a soon-to-be ex's possession.
A typical scenario, according to family-law attorney Robert Kornitzer, at Pashman Stein, a commercial law firm in Hackensack, N.J., is: "You get married young with no prenup and you have a $100,000 business. . . not anticipating that, 20 years later, it's a $5 million business, and now the spouse has some stake in the growth of the business."
If you're not careful in a divorce, you could find your ex is your business partner -- or you could be fighting to keep your enterprise from being sold to raise cash.
Or you might lose the business to your ex. That's what happened to Tereson Dupuy, founder of FuzziBunz, an online cloth-diaper business based in Lafayette, La.
Dupuy launched the company three years into her marriage after seeking better diapering options for her second child. But in 2005, close to the couple's 10-year anniversary, the marriage unraveled. Dupuy discovered FuzziBunz would be considered a joint marital asset. Louisiana is one of a handful "community property" states, including California, which assume each divorcing spouse owns half the property accumulated during the marriage.
Dupuy says the stress of the divorce drove her into a nervous collapse and within 24 hours a judge put her husband in control of the company.
Related: Ugly Breakup
It took Dupuy a year and a large lump-sum payment to her ex -- plus $15,000-a-month payments to her ex over many years -- to regain ownership. The payments drained cash, and bankers considered her need to pay them outstanding debt, making it hard for her to borrow needed growth capital.
Is your marriage headed toward a breakup? Here are seven strategies to consider if a divorce is threatened or already underway and your company is considered a joint asset.
1. Maintain good records, and keep the family's finances separate from those of the business. "Don't borrow out of the house [account] to buy company trucks," Kornitzer says.
2. Pay yourself a good salary. If you starve the family's cash flow to build the business, a lawyer might later make the case that your ex is entitled to more of the company's assets, according to Jeffrey Landers, founder of Bedrock Divorce Advisors LLC, a divorce financial strategy firm based in New York City.
"If you paid yourself $80,000 a year instead of $300,000 and were hoping on retirement to sell the business and enjoy the proceeds together and now that's not happening," he says, "then your ex will want [his or her] share" of the company.
3. Fire your spouse. If your spouse is actively involved in your business, ease him or her out as soon as possible, says divorce lawyer Daniel Clement, principal of New York City family law firm Clement Law. The more prominent the ex's role and the longer he or she worked in the business, the stronger the case a lawyer could make that this spouse helped build the enterprise and should profit from its growth.
4. Sacrifice other assets. In a divorce settlement, a couple's total assets are added up and then divided. Try to retain 100 percent ownership of the business by forfeiting other assets instead, such as retirement accounts, the family's home, vehicles or collectibles, Clement says.
5. Get a fair valuation. Use a neutral, court-appointed valuation professional and then arrange for another outside party to review the figure before you agree to it, Clement says. Dupuy wishes she had challenged FuzziBunz's valuation, which was based on a projection of 10 years of future growth rather than current revenue, she says.
6. Arrange to make any payments over time. It's common to pay an ex for a share of a business gradually, as Dupuy did. The monthly payments can come from the business's cash flow or a bank loan.
7. Raise capital by selling a stake. You could sell a minority stake in your business to employees through an employee stock ownership plan, Landers says. Or find an angel investor or two who will pay cash in exchange for an ownership stake.
One bright spot for entrepreneurs: It's rare that a business ends up being sold off to satisfy a divorce settlement, Clement reports. That's because it would deprive the business owner of the future income needed to pay support payments.
Take action while your relationship is still rosy and you may greatly increase your odds of surviving a divorce with your business intact.
Here are five pre-emptive strategies from attorney Jeffrey Landers that can help protect you from losing your business in a divorce.
1. Sign a prenup. If your business existed before you wed, designate it as separate property owned by only you.
2. Secure an early postnup. This is much like a prenup, except the agreement is signed after the wedding. If a postnup is done long before the marriage disintegrates -- ideally more than seven years before a breakup – it might be useful in defining a business as separate property. But judges often view postnups skeptically.
3. Place the business in a trust. This keeps the business from being counted as a marital asset as you no longer personally own it. The move also protects the value of the company's growth.
4. Create a buy-sell agreement. It defines what happens to a business should any owner's status change, as is the case in a divorce. The agreement might limit a spouse's ability to acquire ownership, deprive a divorcing spouse of voting rights, or give you or other partners the right to buy at a low, preset price any interest awarded the ex.
5. Have insurance. A whole-life insurance policy that builds cash value can be liquidated to provide the funds to buy out a spouse's share of the business, if need be.