Spouses Co-Own a Business – What Happens if They Divorce?
When spouses co-own a business, the impact of divorce goes beyond personal consequences. Divorce will severely affect a jointly-owned business, posing serious implications for the spouses’ financial future.
Is California a Community Property State?
California is one of nine community property states. Under communal law, the division of assets is strictly equal. Barring any prenuptial or postnuptial agreements, the courts will assess all property and allocate one-half of the net assets to each spouse.
How Does Community Property Work?
Community property laws dictate the distribution of assets by strictly defining property as separate or communal. Community property is also referred to as joint property or marital assets.
Separate property is not subject to division. Anything a spouse owns prior to the marriage is separate property. A spouse can also acquire separate property during the marriage under special circumstances.
Gifts and any inherited assets are considered a spouse’s separate property. Non-economic damages in a civil lawsuit, like a personal injury settlement, are separate assets.
A highly contentious subject in divorce is when separate property becomes community property. A spouse cannot simply claim an asset is separate. Any separate property must be verifiable through documentation. If not, the court will assume the asset is community property.
In addition, if a spouse uses a separate asset in a manner that benefits the marital estate, it can be considered communal property. For example, when a spouse uses inherited funds to improve the marital household, they are commingling separate and communal assets. Once mixed, the separate asset is deemed community property.
Community property consists of any debts or assets acquired during the marriage. Regardless of whose name the asset is under, it will be considered jointly owned. Pensions, profit-sharing plans, and 401(k)s are also considered community property.
Community property is divided equally between spouses. Generally, individual assets are not split down the middle. Rather, when one spouse is granted a sizable asset, another asset of equal value is given to the other. In the case of a jointly-owned business, division is more complex.
How Do Communal Property Laws Affect a Co-Owned Business?
A co-owned business is considered community property in a marriage and is subject to division with all other community property. While the court rarely divides individual assets, splitting a company has greater implications.
A business is a separate, living entity from the household. Whether the company is a partnership, LLC, non-profit, or corporation will need to be considered. A business has its own debts, assets, and tax requirements.
A company may own property, major equipment, and inventory. Businesses often have carefully cultivated reputations, including an online presence complete with social media. There may be short and long-term contracts with other entities, including lease agreements or fulfillment centers.
In addition, business relationships will be affected by a divorce. Companies have employees, suppliers, and customers to consider. Depending on the nature of the company, communal property laws could require spouses to divide or liquidate the business.
What Options Are Available to Divorcing Spouses?
Divorcing spouses who co-own a business have a few available options. Some factors to consider include how well the spouses can get along, the value of the business, and whether the company is their only source of income.
Spouses may choose one of the following options:
- Divide the company: Divorcing spouses may choose to divide the company in half. This can be challenging when deciding how to split customers, contracts, and inventory. In addition, spouses should consider the implications of becoming each other’s competition in the market.
- Buy out the partnership: In some cases, a spouse may buy out the other’s interest in the company and continue operations alone.
- Dissolve, sell, or liquidate the company: When spouses have a high-conflict relationship, walking away from the business may be the best option. Selling the company and splitting the proceeds may help ex-spouses to start fresh. If the couple is close to retirement, dissolving the company may be a favorable solution. Liquidating assets and paying off debts can allow each spouse to walk away freely.
- Continue to operate the company together: Keeping the business together may be financially favorable when both spouses can retain an amicable relationship. If a divorcing couple prefers to stay business partners, thoughtful consideration should be applied to the long-term consequences of maintaining professional ties.
The first step to deciding the fate of a family-owned company is to properly evaluate the organization.
How is a Business Valued in California?
A business is valued in California with an evaluation of “goodwill.” In the professional world, a company’s goodwill is an intangible concept that considers the following:
- Does the company have an established reputation?
- Does the company have brand identity and recognition?
- What is the expectation of future business?
- Does it have proprietary technology?
- Is the client base loyal?
- Is the workforce considered talented in its field?
- What is the value of the company if sold on the market?
The court is unlikely to accept the spouse’s valuation of the business. It may require a formal evaluation by a professional.
Evaluating the company is a long and tedious process. Divorcing spouses should take steps to avoid common mistakes that may lead to undervaluing or overvaluing the business.
Common Business Valuation Mistakes
A business valuation mistake can severely impact the division of assets. If the company is liquidated based on an undervaluing error, both spouses can lose considerably. When one spouse buys out the other, an overvaluing of the business will result in a gross unequal division of property.
Common business valuation mistakes include:
- Failing to disclose all of the business’s assets and debts
- Failing to use an accepted method of evaluation
- Not accounting for special circumstances (e.g., unique risks associated with the industry, one-time contracts unlikely to repeat)
- Failing to hire a professional appraiser or forensic accountant
One of the most important steps for divorcing spouses is to prepare the business information. Organize years of tax returns and financial documents regarding assets, liabilities, income, and expenses.