How to Protect Your Company From Your Business Partner's Divorce
Before you formed your business partnership, did you vet your partners’ marriages along with their bank statements? You may not consider it until divorce proceedings are underway, but your partners’ spouses likely own a part of your company, whether you want them to or not.
In my day job as a financial strategist specializing in complicated (and often highly contentious) divorces, I rarely see a case where the day-to-day operations, valuation and ownership structure of a business is not affected in some way by a breakup. If your partner’s soon-to-be ex receives a part of the business in the divorce settlement, you’ll gain a new, unwelcome partner who now has a voice in how your business operates and, by extension, can impact your own net worth.
Michael Lees, a business attorney and partner at Solomon Ward Seidenwurm & Smith in San Diego, recommends including a contingency for divorce in your company’s setup. “Start with a well-drafted partnership, ownership or shareholder agreement that requires a partner’s spouse to sell his or her awarded interest back to the company (or to its co-owners) in the event of divorce,” he says. “This buy-sell provision should contain a comprehensive list of terms and conditions, including the method by which shares will be valued, the transaction timeline and the source of funds to be used for the purchase, such as cash on hand, an existing line of credit and/or a loan.”
To ensure that the “right to purchase” can be upheld in family court, it is worthwhile—and often essential—to have all non-partner spouses consent in writing to all aspects of the agreement long before any marital dispute arises, according to Lees. In the event a buy-back is not possible, this agreement can limit an ex’s voting rights and/or management participation.
Even with such arrangements in place, John Ovrom, CEO of Coronado, Calif.-based Exit Consulting Group, regularly sees divorces play havoc on operations. “If one partner has to step away from the day-to-day operations to tend to his or her divorce, the balance is thrown off,” he says. “Resources are spread thin, resentment increases very quickly, and the partnership begins to look more like a sole proprietorship. The impact on cash flow can be dramatic and devastating.”
Ovrom’s advice is to plan for the worst. Divorce, illness, disability or the death of a loved one will affect your partner’s ability to contribute to the business. “You need to set up a legally binding plan that addresses how to handle these challenges,” he says. “One that answers some basic questions, such as how long one partner can step away from the company before his or her compensation drops. Who will assume his or her daily duties? If a loan or pay advance is needed to cover skyrocketing legal bills, what are reasonable terms?”
These are tough queries, but it’s better to ask them now than in the middle of a messy divorce. Handled correctly, every partner, including you, should come away with a greater sense of trust in one another to do the right thing to preserve the company—even when someone’s personal life is going down the drain.