We live in the age of entrepreneurship, in which many people have forgone the typical employer-employee career to create their own businesses, whether as a sole proprietor, with partners, or even shareholders. Having your own business can be an exciting, albeit unpredictable, alternative to working for someone else’s company, but one area where striking out on your own can make matters more complex is when a business owner gets divorced.
In fact, determining how to deal with the implications of a small business in a divorce can be one of the most challenging, contentious, and emotionally fraught areas of a divorce, and the topic is one befitting of volumes of discussion. This article provides a very brief overview of the type of issues you may confront when a small business owner in California goes through the divorce process.
Understanding Community Property and Your Business
You’re the business owner (or at least you along with your partners are the owners), so the business is completely yours in a divorce, right? Well, not exactly.
In community property states such as California, the law distinguishes between “separate property” and “community property.” Briefly, separate property is the property you had prior to getting married (or received as a gift to you alone after marriage), while community property is the property you earn or acquire with your earnings or labor during marriage. This can be altered through a premarital agreement or postmarital agreement. And, in a divorce, separate property goes to the person who owns it and community property is split 50/50 between the parties.
Basically, if you built a business during the time that you were married, then your property interest in that business will be community property and thus be split 50/50 between you and your spouse in the divorce.
If your business started before your marriage, then there will be two questions:
- The first question will be how much that business has grown in value during the time of the marriage (meaning from the date of the marriage until the date of separation), and that increase in value will potentially be community property.
- The second question will be We say “potentially” because the next question will be whether that increase in value was simply passive income resulting from your efforts before the marriage, in which case that increase could still be considered your separate property, or whether the increase in value was the result of efforts during the marriage, in which case it could be considered community property.
Wait, How Does the Business Get Valued?
If the idea of not only valuing your business – especially in a business where significant value lies in intellectual property and uncertain future sales – both at the date of the wedding and the date of separation sounds complicated, it certainly can be, and is one of the primary reasons why business ownership is such a complex area of divorce law.
As you might expect, there is a tendency on the part of the business-owner spouse to undervalue the community property portion of the business and a tendency on the part of the non-owner spouse to overvalue the community property portion of the business. If the parties disagree on the relevant business valuations, then typically a forensic accountant would need to be retained to provide a valuation of the business. Sometimes both spouses will retain their own forensic accountants to provide dueling business valuations.
A forensic accountant providing a valuation of a business in the context of a divorce will not necessarily just look at the buy-sell value of the business, in other words, what price a potential buyer for the business would pay for it that meets a price the owner would sell it for. A forensic accountant will instead conduct a more holistic assessment of the value of the business, taking into consideration such factors as assets, inventory, and obligations held by the business; revenue; present and future profitability; goodwill; and so on.
This can obviously be a more expensive and involved process than either spouse is interested in pursuing or paying for, but the parties may also, through mediation, agree to have a forensic account provide a more ballpark estimate of the valuation of the business. The last thing spouses would want to do in a divorce is spend more on attorney and accountant fees to determine the valuation of a business than what the dispute amount is actually worth.
Does This Mean My Spouse Owns Half of My Business?
The above may make you concerned that your soon-to-be ex-spouse will be co-running your business going forward, just at the time you thought you were making a clean break from him or her in your life. That’s not what it means, although other factors may lead to that result.
California’s community property laws do not automatically make a spouse the operator of your business (if that were the case, every married person would be jointly managing their business with their spouse, as community property rules apply both during the marriage and after), but rather the spouse is a half-owner of the value of the business.
What this means, however, is that you may need to pay your spouse that $5 million in a divorce judgment, but you may not have that $5 million in cash handy as that company value is mostly in inventory in warehouses. You could take a loan to pay the $5 million or make an agreement to pay it to your spouse over a number of years. Or you could make your spouse joint operator of the business. Often, the business is “horse traded” against other assets such as the family home. In some cases, the business is sold to a third-party and the proceeds are split.
It’s not always clear cut that the business was all separate property or all community property. There may be disputes over the character of the business. More frequently, parties will fight over the value of the business and use “dueling experts”.
Guidance on Your California Family Law Questions From a Westlake Village Family Law Attorney
If you would like to learn more about how our office can provide guidance on any California family law issues you are facing in Ventura County or Los Angeles County, contact the Zonder Family Law Group office today at (805) 777-7740 or (818) 877-0001, or schedule your strategy session using easy-to-use online form here.