If you own or are considering launching a family-owned business with your spouse, you’re not alone. According to the U.S. Census, there are more than 3.8 million family-owned businesses in the United States. Building a family business is an exciting undertaking, but what happens if you decide to divorce? Couples who don’t discuss and establish in writing what happens to the family business following divorce are in for plenty of headaches and potential financial woes.
According to Connatser Family Law Attorney Aubrey Connatser, “Most couples don’t want to think about divorce when they are entering into a business relationship. However, when you’re entering into a business relationship with your spouse, you need to think of it as a business relationship – not a marital relationship.”
Would You Want to Run a Business with Your Ex?
Think about it. In the unlikely scenario that your marriage goes south, how sure are you that your ex-spouse would have your best interests at heart when it comes to the business? For most couples, running a business together post divorce isn’t the best option, so you’re better off getting your ducks in a row at the outset, just in case.
“You wouldn’t enter into a business relationship with your best friend, neighbor down the street or professional acquaintance without making sure you were represented and advocated for by an attorney, who can negotiate a deal that has all of the requisite provisions included in writing to cover what happens upon dissolution of the business or death. In the same vein, a ‘business prenup’ can help couples protect their interests in the event of divorce (and dissolution or death),” advises Aubrey.
You, Not the Court, Should Decide What Happen to Your Business Post-Divorce
Texas is a community property state, and if you don’t put your wishes in writing the family court will decide how the business will be divided should you divorce. According to Aubrey, “The business a couple builds together is typically considered a community asset, so it’s wise for both parties to have counsel who will independently review legal documents. This is especially prudent when one spouse brings considerably more personal goodwill to the business as may be the case in a physician’s practice, a law firm, creative agency or the like.”
Without a written agreement, “there is also the risk that the court could order that the business be split by what is often referred to as a ‘ride along.’ That can be the worst possible scenario for the actual professional business owner spouse such as a prominent attorney or doctor. You don’t want your ex-spouse to be your business partner against your will,” Aubrey says.
There are pitfalls for the other spouse too. As Aubrey explains, “Say the court orders a ‘ride along’ and the husband who is a prominent physician is named constructive trustee of the other spouse’s interests and given fiduciary duties over the business’s operations. That could be the worst case scenario for the wife, because the husband then has the right to determine when distributions are made, and he could essentially choose to starve her out.”
Don’t Let the Court Put Your Business on the Auction Block
If there is a good market and a business is ripe for sale, a court may also order that the business be sold or a receiver be hired to take over the operations of the business. “You lose a lot of control by giving the court the ability to make those decisions and determine what happens when, because timing is everything when it comes to a business. Again, it could be the greatest thing on earth for one spouse, but not for the other,” Aubrey warns.
The business itself can also be put in peril during a contentious divorce. Aubrey finds, “A lot of businesses can be jeopardized in a divorce and the process can drag out without a business prenup in place. What often happens is there will be extensive discovery, numerous people are deposed, and sometimes even customers and clients will be contacted, which could raise concerns. This can be embarrassing for the business owners and may cause some clients to take their business elsewhere.”
5 Key Provisions You Should Consider for Business Prenups
Why risk your business and your sanity by forgoing a business prenup? Aubrey advises couples owning family businesses should either review and amend existing entity documents or construct a new business prenup that takes the following provisions into consideration:
1. Buy out options and/or right of first refusal to buy out the other spouse’s interests and/or the interests of the other partners in the business prior to offering those interests for sale to a third party.
2. Clarification regarding which spouse will buy out the other and who will leave the business in the event of divorce.
3. An anti-dilution clause, where one partner, even if it’s a partner-spouse, can’t dilute the partnership by adding other partners to the entity or business.
4. A pre-determined valuation of the business, that says upon divorce, here’s what the business will be worth and where each spouse signs a spousal consent for the entity that says, “I understand that if we divorce the value given for each share of the business is X.”
5. Confirmation that a business owned by one spouse prior to the marriage remains (or does not remain) separate property. Some spouses who build a business prior to marriage may want to establish that regardless of what the business is worth at the time of divorce, and how much money and effort has been poured into the business during the marriage, any retained earnings that haven’t been distributed and all other assets pertaining to the business remain with the original business owner as separate property.
“No. 5 may require that the original business owner give something else up, say a lump sum of money or other assets, but it may be worth it to avoid the hassles associated with valuing the business and each spouse’s contributions to it during the marriage,” Aubrey explains.
A Reputable Texas Family Law Attorney Can Simplify the Process
The above are just a few of the key considerations couples should take into account when preparing a business prenup. It’s typically best if separate counsel evaluates each spouse’s situation and role in the operation of the business. A Texas divorce attorney with experience handling business prenups can offer advice regarding your individual circumstances.
“There are a lot of unforeseen pitfalls in valuing a business and working through all of the ins and outs of what that entails. If you can pre-establish the value of the business and what each spouse’s role will be post-divorce, you can save yourself unnecessary headaches and help preserve the business’s long-term viability,” Aubrey says.