When considering divorce, spouses often think about the family home, real estate, financial accounts and maybe even retirement accounts. One important asset that should also be considered is whether a family business may be subject to marital distribution.
How to distribute property between spouses according to equitable distribution principles is what most states use. These states try to give each spouse a “fair” share of marital assets, but they are not required to provide a 50/50 division. Other states recognize community property principles and find that property and income during the marriage are owned in equal parts by both spouses, absent an agreement to the contrary or special circumstances.
Divorce may be an emotional trial, however, its roots are based on a financial and legal severance of two people. As part of the divorce process, the assets the couple acquired must be divided. When a family business is at stake, both spouses may have an ownership interest in the business. The court will apply the relevant rules to distribute property between the spouses if the parties are unable to work out an agreement on their own.
Classifying a Family Business
The court must determine whether the business is marital property or community proper, whichever applies, in order to determine ownership rights to the business. In order to classify the business, the court may evaluate a number of factors. For example, the court may look at the date the business was established, the nature of the funds used to start the business, the contributions both parties made to the business, the skill set needed to successfully run the business, the value of the business before the marriage and at the time of divorce and the change in value of the business.
Even if it was established before marriage, the business may not be considered separate property. For example, if the parties mingled separate and marital funds during the marriage into the business or if the non-owner spouse quit his or her job to contribute to the business, a concept called transmutation may apply which means that personal separate property becomes marital property.
Likewise, a business acquired during the marriage may not be considered marital property if it was purchased during the marriage in some cases. For example, a family business that was inherited or received as a gift may not be marital property. Alternatively, a written agreement between the spouses may allow just one spouse to be considered the owner.
It is also possible for part of the business to be considered separate property and part of it to be considered marital property. Both spouses may not have an equal share in the business, either. Additionally, the ownership interests of other partners must also be considered.
Valuing the Business
The business may need to be valued once the classification of the business is completed. There are a variety of ways to determine the value of the business. One way is to estimate the value of the business by comparing it to a similar business. This is similar to looking at comparable on the real estate market. Having a forensic accountant or professional appraiser review the information, including tax returns and financial statements in order to determine an independent value of the business is another way to evaluate it. The asset approach compares the assets and liabilities of the business to determine the value. Finally, the income approach places a value on the business by looking at the cash flow of the business.
Expert witnesses, in complex cases, may testify about the value of the business and how that number was figured. The judge will ultimately make a decision on the value of the business. Some states allow the judge to consider the business’ goodwill while others do not. Goodwill is basically the value associated with the business’ reputation.
Once the judge determines the value of the business, he or she does not usually award the right to the non-owner spouse to run the business. Instead, this spouse is awarded his or her portion of the business’ value.