Minimizing the Impact of Divorce on a Small Business

Divorce is never easy, but for business owners it can be especially complicated and costly because the business entity may represent the most valuable asset owned by the married couple.

The impact of a divorce on the finances of a closely held business depends on many different factors, the biggest one being whether the business is considered to be separate or marital property. If it’s separate property, the business may not be included among the marital assets to be distributed between spouses. If it’s marital property, the business likely will be viewed as a marital asset, along with homes, cars, investment portfolios, life insurance, and the like, subject to distribution upon divorce.

In general, separate property is any property owned by either spouse before the marriage as well as inheritances or gifts received solely by one spouse during the marriage. Conversely, marital property is all income and assets acquired by either spouse during the marriage, including a closely held business.

Note that if a business incorporated before marriage increases in value during the marriage, the increased value may be considered marital property. For example, if a business was worth $1 million when the owner got married but its value had increased to $2 million at the time of divorce, the $1 million increase in value could be considered marital property subject to distribution upon divorce. The assets of the business generally must be split up between spouses, unless the spouses are both active in the business and want to continue working together after the divorce. How this is done depends on many factors, not the least of which is determining the business’s value, and usually becomes a key part of the divorce negotiations.

Ideally, spouses work out a financial arrangement during mediation that helps ensure the ongoing viability of the business and provides a fair settlement for the nonparticipating spouse after the divorce. For example, they could agree that the nonparticipating spouse will receive a financial payout from the participating spouse upon divorce. This could be in the form of a lump-sum payment or a stream of payments over time. With a lump-sum payment, the spouse who will retain ownership of the business must ensure that the business can absorb the financial impact of the payout or make the payout from other nonbusiness assets such as cash, stocks, real estate, or retirement funds.

Making installment payments over time is often less disruptive to the business’s (and the owner’s) finances. This is usually accomplished via a property settlement note, which spells out the details of a long-term payout, often with interest, of the nonparticipating spouse’s ownership share of the ongoing business.

Of course, the business could be sold and the sale price divided between spouses. This is usually the least preferred option but often happens when the business represents the bulk of the couple’s assets and there is no other feasible way to settle the marital estate.

The best way to minimize the impact of a divorce upon a business’s finances is to plan well in advance for the possibility of divorce and detail what will happen to the business if it occurs. A prenuptial agreement is usually the best way to accomplish this. This enables spouses to determine ahead of time what property will be considered marital and what will be considered separate and how marital property would be divided in case they should divorce.

If you’re already married, it’s obviously too late for a prenuptial agreement, but you can create a postnuptial agreement to accomplish the same thing. Note, however, that postnuptial agreements are challenged and invalidated more frequently than prenuptials, and not all states recognize them.