Family businesses face many challenges as they strive to survive and thrive. Among the most difficult to overcome is one that is unique to a closely held business: divorce.
A divorce can be financially and emotionally devastating to a family business. We have all overheard a business owner referring to his or her company as being “like a child.” The custody battle for the business can be expensive, contentious and, without proper planning in advance, potentially fatal.
This is particularly true if a company has been jointly owned and its growth has been a labor of love for both spouses. Even when one spouse is a non-owner who does not work actively in the business, the company is frequently a couple’s largest asset; thus its value becomes a point of contention in divorce proceedings.
For a family business to survive a divorce, the possibility of divorce must be anticipated and planned for well in advance. While nobody wants to imagine a time when a marriage is dissolved, it is inexcusable to ignore the possibility.
The incorporation documents of every closely held business should include an agreement about ownership rights and stakeholder value in the event of an owner’s divorce. Succession planning documents should also include provisions for the dissolution of the marriage of one or more of the next generation of owners.
Disposition of the business can be addressed in a premarital or post-marital agreement, carefully structured and negotiated to provide certainty in the event of a divorce. Every possible permutation of what might occur should be considered and addressed, such as spouses who are joint owners, a non-owning spouse who acquires a share in the business as marital property, and stakeholders who are not party to the divorce but whose ownership is affected, among others.
A variety of options exist to resolve the issues of ownership and control of a closely held business upon the divorce of one or more owners. It is generally in the best interests of both parties to the divorce if a business remains a viable operation, although this is not always possible.
Buyout of a Spouse’s Share
One solution to settle control of a business in a divorce is for one spouse to buy the other spouse’s ownership interest, or for the spouse who is an owner to compensate the non-owning spouse for the value of the owner spouse’s interest in the business. A typical hurdle is finding a valuation method and pinpointing a number on which both parties can agree. The services of an independent certified value analyst (CVA) may be required.
Transfer or Redemption of Shares
If a non-owner spouse receives ownership shares in the business as part of a divorce settlement, it may be in his or her best interest to “cash in” by transferring the shares back to the company in return for cash. This may put a financial strain on the business (and the owning spouse), but can also create a clean break that leaves control of the business with the active spouse.
Sell the Company
If the divorcing couple does not have a binding agreement in place and cannot come to terms on how to divide their interest in the business, it may come down to selling the business to a third party. The downside is that the income stream from the business is eliminated, and the forced sale of a distressed business may lower the sale price.
In some cases a business may be in a financial position that precludes buying back shares, the company may not fetch an acceptable price if sold, or both spouses may simply wish to see the business continue, and therefore come to an agreement to remain co-owners. Some even keep their business partnerships in place for the sake of any children who may be employed in the family business.
Divide the Business
If both divorcing spouses desire to continue in the business, one option is to split the business into two separate companies, each owned by one of the divorcing spouses. This works well when a business has multiple divisions or business units that can be run separately, or when a company’s real estate assets can be split off from the operating business.
All of the possible resolutions cited above carry important – often overriding – tax implications. Decisions about how shares are transferred, redeemed, purchased or otherwise shifted from one spouse to another should always be made with the goal of minimizing the tax burden for all parties.
According to federal statistics, the divorce rate in the U.S. is 50 percent, so it is almost inevitable that divorce will affect closely held business owners. Accepting this possibility and creating a well considered plan ahead of time can help reduce uncertainty at a time of great stress and disharmony.
Edward D. Tarlow is a founder and shareholder at Tarlow Breed Hart & Rodgers, a Boston law firm that specializes in family businesses, and a founder and president of the Family Business Association of Massachusetts. This article first appeared in the Spring 2016 issue of Massachusetts Family Business magazine.