How Can an Entrepreneur Protect Their Interests During a Divorce?

 Posted on August 11, 2023 in Division of Assets

The divorce process can often be complicated, regardless of a couple’s circumstances. Myriad financial issues will need to be addressed when dividing marital property and determining whether financial support will be paid by one party to the other. At the same time, strong emotions can affect both parties, leading to contentious disputes that may make it difficult to resolve the various legal and financial concerns that may arise. For entrepreneurs and business owners, these issues can cause problems as they determine how to protect their financial interests and make sure they will be able to move forward successfully after the completion of a divorce.

At Weiss-Kunz & Oliver, LLC, we understand the concerns faced by entrepreneurs who are planning to get divorced. We know that business owners will be looking to protect their interests, ensure that they can maintain ownership and control of the companies they have built, and sustain ongoing financial success for many years to come. With our knowledge of the laws that affect entrepreneurs who get divorced and our experience helping our clients resolve complex legal and financial issues, we can help ensure that a divorce can be completed as smoothly as possible.

The Importance of Business Valuation

Some of the most crucial issues that entrepreneurs will need to address during a divorce will be related to determining the value of their business interests. A comprehensive understanding of a business’s current and future value will be necessary to ensure that financial concerns can be addressed correctly when dividing marital assets. If a business is considered marital property because it was founded or acquired during the marriage, both spouses will need to understand its value so that it can be divided along with other assets a couple owns. However, even if a business is separate property that one spouse owned before getting married, understanding its value will be necessary, since this will ensure that the business owner’s financial status will be properly considered when addressing divorce-related issues.

There are a number of business valuation methods that can provide an objective assessment of the worth of a company. These include:

• Asset-based valuation: This approach focuses on identifying and assessing tangible and intangible assets owned by the business. Tangible assets may include inventory, equipment, real estate property, and other physical items, while intangible assets may include intellectual property rights such as patents or trademarks. The value of all assets owned by a business may be added together, and debts or liabilities may then be subtracted to determine the business’s value. While this method can provide an easily-understandable figure, it may not take other factors that may affect a business’s value into account, such as the potential for future growth.

• Market value: This method determines a business’s value by comparing similar businesses that have recently sold or are currently on the market. Factors such as industry market conditions, asset values, profitability ratios, and comparable sales data may also be taken into account to determine how they may affect a business’s sale price. While this form of valuation can help determine the amount the owner would receive if their business was sold, it may not address other issues that could affect the business’s value, such as goodwill and positive reputation, the relationships the owner of a professional practice has cultivated with customers or vendors, and the knowledge and experience of the owner and other key personnel.

• Cash flow analysis: This approach evaluates historical financial statements and projected cash flows to determine the earning potential of the business. It takes into account revenue, expenses, assets, liabilities, and risks associated with the business. This can not only establish the current value of the business, but it can provide an understanding of the business’s expected growth in the future. 

• Earnings multiplier: This approach calculates value based on projected future earnings potential by applying multipliers specific to the industry or type of business being valued.  Different multipliers may be used for specific industries, and factors such as growth prospects, risk levels associated with those industries, and prevailing industry standards may be taken into account. Applying the appropriate multiplier to a business’s anticipated net income can yield an estimate of the company's value. It may be necessary to make adjustments for extraordinary one-time events or non-recurring expenses that would not affect future profitability. This ensures accuracy in determining future earning potential. 

The Role of Prenuptial and Postnuptial Agreements

Prenuptial agreements and postnuptial agreements can play a vital role in protecting an entrepreneur's interests during a divorce. These legal documents provide guidelines for how assets will be divided if a marriage ends in separation or divorce. 

A prenuptial agreement may be created before a couple’s marriage, and it may specify how ownership of certain assets will be handled during a couple’s marriage. For entrepreneurs who were business owners prior to getting married, a prenup may protect their business and ensure that they can maintain sole ownership in the event of a divorce. 

A postnuptial agreement may be created after marriage but before separation or divorce occurs. It will typically address issues such as property division and spousal support. If an entrepreneur founded a business while they were married or invested in an existing company, they may use a postnup to ensure that they will be able to maintain ownership of their business interests if they get divorced. A postnuptial agreement can also address other financial issues, ensuring that both spouses will have sufficient resources to support themselves after their marriage ends.

Business owners who have a prenup or postnup will need to be sure to understand how the terms of an agreement will affect their divorce. A close review of an agreement can ensure that its terms are valid and enforceable and that all issues related to business ownership will be handled correctly when dividing marital property or resolving other financial concerns. 

Options for Dividing Business Interests

Entrepreneurs and their spouses will need to understand how ownership of a business will be handled after their divorce has been finalized. A business owned by one or both spouses or investments in different companies can be valuable assets, and both parties will want to be sure they will receive an equitable share of the property they own together. Some options that may be available to spouses as they address ownership of a family business, professional practice, or another type of company may include:

• Sell the business: In some cases, a couple may decide that continued ownership of a business will not be feasible. If neither party wants to continue owning and operating the company, or if a couple cannot agree on how to manage a family business together post-divorce, selling the business to a new owner may be the most preferable option. This allows both parties to liquidate their ownership shares and divide any resulting proceeds or debts equally between them. 

• Buyout by one spouse: An alternative approach is for one spouse to buy out any interests the other spouse owns in a business. When an entrepreneur maintains full ownership of a company, they will compensate the other spouse with cash or marital assets that have a similar value to that spouse’s ownership share of the business. This option may be preferred if one spouse has played a more substantial role in building and running the company than their partner. A person who was actively involved in day-to-day business operations and who has unique industry knowledge may be better suited to ensure that they can continue operating the business successfully. This will allow the business owner to continue generating income through the company, and the other spouse will have sufficient financial resources to address their needs.

• Co-ownership or partnership: In some cases, divorcing couples may choose to continue co-owning or operating a business together even though they will no longer be married. This option can work well if both parties are willing to maintain a professional working relationship and are able to set aside personal differences for the sake of the company's success. It can also ensure that spouses who have both been involved in building and operating a business can continue to reap the rewards of their efforts. If spouses decide on this course of action, it is vital that they establish clear guidelines outlining how decisions will be made and how disputes will be resolved moving forward. A well-crafted partnership agreement can be crucial in these situations, since it can establish clear roles and responsibilities and make sure the co-owners will be able to address ongoing business-related concerns. It may also be a good idea to develop a buyout agreement in the event that one party wishes to assume full ownership of the business at a later date or if circumstances warrant the sale of the business in the future.

Tax Concerns for Divorcing Entrepreneurs

When addressing issues related to the ownership of a business and the division of marital assets, it is important to understand the different types of tax issues that may play a role in these matters. A business’s structure and tax classification will affect the types of taxes that the owner may be required to pay, and it may also affect decisions about property ownership and division during divorce. Some common business structures include:

• Sole proprietorship: This is the simplest form of business ownership in which an individual owns and operates the enterprise. There is no separation between assets owned by the business and the owner’s personal assets. In addition to being taxed on the income generated by the business, the owner may be required to pay self-employment taxes. 

• Partnership: A partnership exists when two or more individuals share ownership and operational responsibilities. If a spouse has a business partner who co-owns the company, it will be necessary to determine each partner’s ownership share, and the taxes each partner pays may also need to be considered. Depending on whether a business is a general partnership or limited partnership, different types of taxes may apply to a business owner following their divorce.

• Limited liability company (LLC): This type of business structure offers personal liability protection while maintaining flexibility in management and operations. An LLC may have multiple owners or investors who are known as members, and this may affect the types of business assets that will need to be considered during the property division process. A business owner will also need to understand how business income may be taxed going forward, including the “pass-through” deductions that may be available.

• Corporation: These are distinct legal entities that are taxed separately from their owners. They offer personal liability protection, but profits may be subject to double taxation in some cases. Entrepreneurs may need to determine how the shares they own in a corporation will be addressed during their divorce and how the income and profits they earn will be taxed going forward.

A business’s classification will significantly impact the taxes that a business owner will be required to pay going forward. By addressing these issues during a divorce settlement, an entrepreneur can plan for financial success in the future and ensure that they will be able to earn enough income to meet their ongoing needs.

The sale of a business during or after a divorce may trigger capital gains taxes that will need to be paid. Capital gains may include any profits earned through selling shares of a business. While the transfer of business assets between spouses during a divorce will not result in capital gains taxes, the sale of business interests to other parties may require the payment of these types of taxes. If a business is sold at a loss, one or both spouses may be able to claim deductions based on these losses. 

According to IRS guidelines, short-term capital gains (profits earned on assets held for one year or less) are taxed at regular income tax rates, while long-term capital gains on assets held more than one year may be taxed at either 0 percent, 15 percent, or 20 percent, with the applicable rate being based on the taxable income of the person who sold assets. Entrepreneurs may need to consult with tax professionals to determine what capital gains tax obligations may apply when selling or transferring assets during a divorce.

Contact Our DuPage County Asset Division Lawyers

If you are an entrepreneur who is going through a divorce, it is imperative to consult with an experienced divorce lawyer who understands the financial issues that may play a role in your case. The team of Elmhurst property division attorneys at Weiss-Kunz & Oliver, LLC can advise you on the methods that may be used to determine the value of your business assets, the options for dividing business interests and other marital property, and the tax issues that may affect you. To learn more about how we can help protect your interests during your divorce, contact us at 312-605-4041 and set up a consultation today.

Sources:

https://www.investopedia.com/terms/b/business-valuation.asp

https://www.nerdwallet.com/article/taxes/capital-gains-tax-rates