Selling a Business During a Divorce
Your small business is a marital asset, like your home or joint bank accounts. A divorce won’t necessarily mean that you’ll lose your business, but it will become part of the financial settlement when you and your spouse call it quits.
Whether and when you may sell your business and how the proceeds are divided between you and your spouse becomes part of the divorce settlement. You’ll need to determine the value of the business, and you and your spouse will have to agree on a course of action.
What Is Marital Property?
Marital property is a legal term that refers to assets and liabilities acquired during a marriage. Ownership interest in a business is considered property, like your marital home and vehicles. It can be divided between spouses as part of the divorce settlement.
Most states regard property acquired by one spouse before the marriage as separate property. That is, it belongs to the one spouse who bought it and isn’t considered marital property.
When you marry, however, it’s not uncommon for separate property to become marital property. If you added your spouse’s name to your business formation documents, wrote checks for your business on a joint bank account co-owned by your spouse, or your spouse worked at the business during your marriage, your business will likely be treated as marital property even if you are the sole owner.
Any increase in the value of a business during the marriage is also treated as marital property (even when the business isn’t), and it can be divided according to state laws.
How States Divide Your Business Assets in a Divorce
The first step is determining whether your business is marital property. If it is, where you live will determine how it’s divided during a divorce.
Most states are common law states. According to common law, your business is considered separate if you alone acquired it, regardless of whether it was before or during your marriage.
On the other hand, if you live in a community property state, your business became marital property when you married, even if you remained the sole owner and your spouse has no involvement in the business.
In general, states use one of two methods—equitable distribution or community property—to distribute marital assets between spouses, although some states blend the two methods.
How Community Property Is Divided
Community property states require property and debts to be distributed equally between two divorcing spouses.
How Property Is Divided Under Equitable Distribution
Most states follow the equitable distribution method for property division. Equitable distribution is not the same as equal distribution. A judge or mediator determines what’s fair based on the specific circumstances of the marriage.
Some of the factors a court can consider in deciding the equitable distribution of business interests include:
- Length of the marriage
- Length of time the business has operated
- Source of funds used to start the business
- Contributions made by each spouse in acquiring, running, and improving the business
- Each spouse’s economic circumstances
- Each spouse’s ability to earn income
- Each spouse’s debts and liabilities
Here’s an example of how equitable distribution might work to divide business assets:
Paul acquired a business before marriage and has run it as the sole owner ever since. His spouse, Pat, however, has done all the billing and accounting for the business. A judge or mediator might determine that Pat, who doesn’t own any portion of the business, has a right to 60% of the value of the business or any percentage the judge deems “fair” based on the contribution Pat has made to the business.
Options for Selling Your Business in a Divorce
If your business is marital property and your spouse is entitled to a portion of it, you’ll both have to agree on a course of action for determining what happens to the business.
While one option is to co-own the business, not every couple can maintain an amicable relationship after divorcing. Remaining tied to a family business can put added strain on what’s already an emotionally trying time.
Unless you are certain you’d be better business partners than you were marriage partners, you’ll probably want to opt for one of three options:
- Buy out your spouse’s share of the business
- Sell the business
- Liquidate the business
If you and your spouse can’t agree on which option to choose, a court will decide for you.
Buy-Out
A typical solution when one spouse wants to continue running the business is to buy out the other spouse’s interest in the business. You’ll need to determine the value of the business, but you might be able to arrange a trade instead of a cash buy-out.
Here’s an example of the way a 50/50 split of the business might be arranged when one spouse doesn’t have the cash to buy out the other:
Jane owns a business she wants to keep after a divorce. Her spouse, John, is only concerned about getting the value of his share of the business and doesn’t want to own it. The business is valued at $400,000, and John is entitled to half of the value of the business, or $200,000.
Jane and John also own a home valued at $400,000, and each is entitled to half the value of the home. Instead of paying John $200,000 for his share of the business, Jane might agree to give up her portion of the marital home, using the home to compensate John for his interest in the business.
Sell the Business
When both spouses agree to sever ties with the business, they can sell it to a third party. However, keep in mind that selling a business can take time, and you’ll have to agree on how the business will be run in the meantime.
Liquidate the Business
If you and your spouse agree to close the business, you can arrange to liquidate the assets and split the proceeds according to your state’s laws.
Your Business Entity Type Can Affect the Sale of Your Business
Sole proprietors don’t have to answer to other owners. In theory, they can sell, buy-out, or liquidate a business as they see fit. Other business types, however, may be subject to rules imposed by the business structure.
What Happens in a Limited Liability Company
The operating agreement or buy-sell agreement of a multi-member LLC usually includes rules for transferring or selling a membership interest.
Most LLC members don’t want to be forced to work with a business owner they didn’t choose. Their operating agreements restrict ownership in the business for that reason.
If it turns out that your spouse is entitled to a portion of your membership interest in the LLC, you’ll usually have several options for dealing with the business:
- Sell your membership interest according to the provisions of the buy-sell agreement (usually by selling your share of the business back to the LLC), or
- Buy out the portion of interest your spouse receives in the divorce, thereby retaining your membership interest in the business.
Some operating agreements allow a spouse who receives an interest in the LLC in a divorce to keep it and collect any distributions made by the LLC without participating in the business.
What Happens in a Partnership
Like an LLC, what happens to your ownership share in a partnership will be determined by the partnership agreement or a buy-sell agreement, if there is one.
A spouse who isn’t a partner in the business might not be able to assume ownership, and the other spouse may be forced to sell their interest back to the remaining partners or buy out their spouse’s portion of the business.
What Happens in a Corporation
When a business is structured as a corporation, the corporation, not the individual shareholders, owns the company assets. A shareholder who is divorcing can be responsible for turning over a portion of the shares owned, but not the corporation itself.
Determining When to Sell Your Business If You’re Divorcing
When you can sell your business during a divorce depends on whether it’s separate or marital property, as outlined above.
If your business isn’t marital property, you can sell it before you begin divorce proceedings. You won’t need your spouse’s consent, but you’ll probably have to share at least some of the sale proceeds as part of your divorce agreement.
However, you can’t sell or close your business to avoid child support or alimony.
It’s important to note that regardless of your state’s property laws, your spouse can prevent you from selling the business until the divorce is settled if they can show the court that the sale would erode or damage their share. The court would issue a restraining order preventing the sale until the divorce is final.
If you live in a community property state and acquired the business during your marriage, you can’t transfer or sell it without your spouse’s approval. As a practical matter, if you and your spouse are locked in battle, but haven’t yet begun divorce proceedings, you won’t be able to sell your business until you and your spouse have come to terms with the division of assets.
Determining the Value of a Business in a Divorce
Before you can divide your business assets, you’ll need to know the value of the business.
Agreeing on a business valuation can be contentious when a couple is divorcing. A spouse who wants to keep the business will want to minimize its value to reduce the amount they’ll have to pay to buy out the other spouse. Meanwhile, the other spouse will want the business value to be as high as possible to increase the amount they’ll receive in a buy-out.
Spouses who agree to sell or liquidate a business can face similar disagreements if one spouse’s finances will be evaluated for paying child support or alimony.
It’s not uncommon for both spouses in a divorce case to hire their own independent, third-party business appraiser to conduct a business valuation and hash out a value agreeable to them.
Get Good Legal Advice
Whether you want to keep or sell your business, you’ll need solid legal advice to guide you through the divorce process.
If you and your spouse co-own the business, a divorce attorney and a family law attorney can be invaluable in finding a resolution for your business and ironing out your divorce agreement.
Selling a business is a complex process, and even more so when selling during a divorce. Assembling a team of experts, such as business brokers, appraisers, accountants, and legal representation, is a necessary step. Visit the BizBuySell Broker Directory to search for experienced business brokers who can provide insight into selling a business during a divorce.
This article provides information solely for educational purposes and should not be considered a replacement for professional legal guidance. Consult an attorney for legal guidance and representation.