If you are married, and you and your spouse run a business together, you may wonder: What happens to the business if the two of you divorce?
The answer depends on two questions: When was the business formed? And are you both actually owners of the business?
Travis owns the business, but owes Tracy half its value…
Travis and Tracy own and operate a flower shop together. The shop is owned by an LLC, which was formed after the date of marriage, so it is 100% marital property. However, the LLC is only in Travis’s name, and there is no operating agreement. This probably means that Tracy’s marital interest in the business is limited to the value of the business, so Travis will need to buy Tracy out, and then he will continue to own the business. Tracy and Travis will need to come up with a value of the business, either by getting a business valuation performed by a professional, or by coming up with a formula that they both agree to. Travis will owe Tracy one-half of the value of the business as part of the division of their marital assets.
Or they both own the business, and must decide how to proceed.
It is possible that emails, tax returns, or the course of conduct between Tracy and Travis might make it clear that Tracy is also an owner of the business. If that is the case, then they will need to decide if one of them is going to buy the other out, or if they will continue to own and operate the business together. An owner of a business cannot be forced to give up their share, so if a buyout is going to happen, the parties will need to agree on all the steps: a value of the business (or have a business valuation performed), and the execution of a membership interest transfer agreement to officially convey the departing partner’s ownership interest to the other partner.
If the business is a corporation…
If the business were a C corporation instead of an LLC, we would look to the bylaws and shareholders’ agreement to determine the ownership percentages of the company, as well as any procedures that govern how to buy one party out. If there are no corporate documents, but the corporation is in both names, the presumption will be that the ownership is 50/50. If the corporation is only in one party’s name, the other spouse will only have a marital interest in the corporation – meaning, they will be entitled to 50% of the value of the company, but not the ownership of it.
What if the business started before the marriage?
Let’s assume, alternatively, that Tracy started the flower shop before the date of marriage. In that case, the ownership is clear: it is hers. However, for purposes of their property split, it is a mixed asset: part separate and part marital. The value of the company as of the date of marriage is Tracy’s separate property, but any activities toward the growth of the business that occurred during the marriage are marital property. This obviously becomes difficult to calculate, because we would need a value of the business as of the date of the marriage, which might be quite some time in the past. As above, the parties can agree to a formula for “ballparking” the values – past and present – or a formal business valuation can be obtained.
Agreements made before problems arise can make things easier when they do.
If Tracy wanted to protect her business from Travis’ marital interest, she could have done that prior to marriage through the execution of a prenuptial agreement, or she could do it through a post-nuptial agreement, which is executed after the marriage has already occurred. Of course, in both these cases, Travis would have to agree to sign this type of contract.
In the case of a business that is jointly owned by a married couple, the best plan is to execute an operating agreement in the case of an LLC, or bylaws and a shareholders’ agreement in the case of a C-corporation. These corporate documents can spell out what would happen in the event of divorce, and the applicable procedures for any buyout.
Dividing a business as part of a divorce means overcoming a few additional hurdles in the form of valuing the business and executing ownership transfer documents. As always, the more you and your spouse can agree on the variables, the easier the process will be.