The sad truth is that the entrepreneurial lifestyle can wreak havoc on a marriage. Many entrepreneurs focus most of their time and energy on making their business succeed. Working long hours, spending lots of time away from home, and depleting the marital bank account are just a few factors that may contribute to the dissolution of an entrepreneur’s marriage.
Entrepreneurship is risky. Your business may thrive and become hugely successful, or it may tank and force you into bankruptcy. You may be able to spend enough time at home fulfilling your needs as a spouse and parent, or you may (even unintentionally) sacrifice your home life in order to help your business venture succeed. Because the divorce rate is higher amongst entrepreneurs, it is important for entrepreneurs to be aware of what to expect during a divorce.
Divorce for entrepreneurs can be more complicated than divorce for those with traditional jobs. Income is hard to calculate, which means it is hard to discuss child support obligations and alimony payments. Perhaps the most complicated aspect of an entrepreneur’s divorce is equitable distribution.
How Equitable Distribution Works
Equitable Distribution is the legal term used to refer to the concept of dividing a couple’s assets and debts. A four-step process is employed to determine how to divide property in North Carolina. First the property must be identified – all assets and debts must be disclosed. Everything, whether marital or separate, must be identified.
Next, the property must be classified. Each identified asset or debt will be considered either marital or separate. The definition of marital property is found in section 50-20(b)(1) of the North Carolina General Statutes — all real and personal property acquired by either spouse during the course of the marriage and before the date of separation, and “presently owned,” except property determined to be separate property in accordance with the statute. Separate property is defined in our statutes as all real and personal property acquired before marriage, or property acquired during the marriage by bequest, devise, descent or gift.
After identification and classification, a value must be assigned to all property. The appropriate value to use is the fair market value as of the date of separation. And finally, the property must be distributed. More often than not, marital property is divided evenly, with each spouse taking fifty percent. There are, however, many factors that the court can consider that would result in an unequal division.
There are several ways in which equitable distribution can be more complicated for an entrepreneur than for someone working a traditional job. If any portion of your business is deemed a marital asset, how do you place a value on your business venture? Can it be deemed a marital asset if it was started prior to the date of marriage? How can you buy your spouse out of your business if you don’t have enough cash on hand? We will discuss each of these questions and more throughout the course of this article.
Classification: Separate v. Marital
Generally speaking, a business interest acquired during the marriage, with joint funds, is considered a marital asset, and the value should be shared by the spouses equally. Alternatively, if the business interest was owned prior to the date of marriage, or acquired with separate funds, it should be considered separate property. This is the baseline rule, however the classification step can prove much more complicated.
The simple fat that the business interest was acquired or that the venture began prior to the date of marriage, it does not mean that the non-owner spouse can take no value from it.
Let’s look at an example. Say a wife owns a marketing company that was started five years before she married her husband. During the marriage, however, she invested $20,000 worth of marital funds into the marketing company. Then, thanks to effort she put into her company during the marriage, the business saw a dramatic increase in revenue. In this case, the husband would be entitled to half of the $20,000 of marital property that was given to the marketing company as well as half of the value of any increase in the value of the business thanks to her efforts during the marriage.
As you can see, it is not as simple as labeling a business as marital or separate simply by determining if it was acquired prior to the date of marriage. First, you will need to look at the date of marriage and the date the business interest was acquired. Second, you should look to the source of funds used to start the business, and finally, the financial and labor-related contributions to the business given by either spouse during the marriage.
Determining the value of a business interest will probably be one of the most complicated aspects of any entrepreneur’s divorce. Inevitably the non-entrepreneur spouse will place a higher value on the business than the entrepreneur spouse will, making this also one of the most contentious aspects of an entrepreneur’s divorce.
There are three approaches to how you can go about determining a value of a business interest: the asset approach, the market approach, and the income approach.
The asset approach calculates a value using a fairly simple formula: assets minus liabilities = value. Assets include both tangible and intangible assets. Tangible assets include the infrastructure, inventory, and anything else related to the business that you can actually touch. Intangible assets are patents, accounts receivables, and other assets that are not actually physical objects. While this approach seems straightforward, it can actually be rather difficult. For instance, how do you place a value on the business assets? Some items, like company vehicles, may be easy to value by using a value book. Other items, such as the computers in the office, or the tables in a restaurant would be harder to place a value on. Additionally, an issue arises when it comes to valuing inventory as well. Typically inventory is valued at cost, but this can vary based on the age and type of inventory. Furthermore, there may not be a value book that covers the type of inventory at issue. This approach also doesn’t take into consideration any unrecorded assets and liabilities which could create further issues; consider a significant unrecorded loan being given to a family member around the same time the business was being valued. Because of the complications mentioned, this approach tends to work best for small businesses.
The market approach calculates the value of a business by comparing it to similar businesses that have been sold. This approach is similar to how appraisers will look at “comps” in a neighborhood when determining the value of the house being appraised. This approach can prove difficult, however, if there are no similar businesses that have recently been sold that can provide an accurate comp.
The income approach uses historical information and particular formulas to predict expected cash flow and profits in calculating the value of the business. The formulas used consider future benefits as well as the rate of risk or return. This is the most common approached used to determine a value of a business.
You may be wondering who actually runs these calculations and comes up with an appropriate figure. Well, if your business is small and there is minimal dispute over it’s value, then you and your former spouse may be able to reach an agreement regarding the value of the business.
Sometimes, if the interest is small and not overly complex, attorneys may place a value on the business. More often than not, however, an expert is needed to dig into the history, finances, assets, liabilities, and other aspects of the business to determine a value. These experts will use one of the approaches listed above in arriving at a number they feel is a fair estimate of a person’s interest in a particular business. Usually, the expert will be a Certified Business Appraiser (CBA) or an Accredited Senior Appraiser (ASA). Sometimes a Certified Public Accountant (CPA) will be called on to help value a business interest. If your case calls for such an expert, your attorney will certainly have a referral for an expert of this caliber to help in your case.
After identification, classification, and valuation have all been completed, you will still need to distribute the value of the business interest. The most common way to do this is by buying the non-entrepreneur spouse out. But the buyout out only works if the entrepreneur spouse has enough cash on hand to satisfy the non-entrepreneur spouse.
Usually in a buy-out situation the buying spouse will just transfer the lump sum owed to the selling spouse. Sometimes, however, spouses may agree to structure the buyout to take place over time. The buyout out only works if the entrepreneur spouse has enough cash on hand now (or will in the near future) to satisfy the non-entrepreneur spouse.
A variation on the traditional buyout is a where a business owner offsets the amount he would have had to pay in cash by trading another asset. For instance if the buyout would require the entrepreneur to give the non-entrepreneur spouse $100,000, the entrepreneur may chose to give his former spouse an asset worth similar value. Perhaps the entrepreneur would allow the spouse to be awarded more personal property, a lucrative investment account, a vacation home, or something else of similar value.
Another option for a divorcing entrepreneur is to allow co-ownership of his business venture with his former spouse. This option clearly has its drawbacks, however, and requires you to maintain a good working relationship with your former spouse. It only works in situations where the parties are amicable and can continue to trust and respect each other despite the dissolution of the marriage.
The third, and least popular option would be to sell the business and divide the proceeds. This is usually a last resort for a divorcing entrepreneur. Considering for many entrepreneurs, the business acted as a catalyst for the divorce, the last thing the entrepreneur wants to do is lose his spouse and his dream.
Selling the business requires attention to certain considerations. For instance, if the business is obscure or not very profitable it may take a significant amount of time to find a buyer. Also, market fluctuations can have a serious impact on the value of the business. Perhaps a business may not be valued very high during an economic downturn, but would be worth a considerably greater amount in a better economic climate.
Property Settlement is Final
Keep in mind that once you reach an agreement or receive a court order on equitable distribution, save for exceptional circumstances, there is no modifying or altering the terms of equitable distribution. This can work to an entrepreneur’s advantage. It often takes many years to get a business venture to a place where it is thriving. If your business wasn’t profitable and you were barely getting by during the marriage, your property settlement will reflect this.
If years down the road your hard work pays off and the business becomes lucrative, you can rest assured that the property settlement you agreed to cannot later be modified. Your former spouse cannot seek a larger settlement based on the notion that your have newfound wealth and a different lifestyle thanks to the success of your business venture.