What Happens to the Family Business if I Get Divorced?
In the state of New Mexico, assets belonging to a married person are considered to be community property, including most businesses whose proceeds “pass through” the finances of one or both spouses. This can mean the business is eligible to be considered as a marital asset that gets split during a New Mexico divorce. In these cases, the business value must be liquidated, or the value of the business must be shared between the spouses through the use of financial “offsets” that include property, cash, or other holdings.
The classification of the business as a shared asset and the division of the value of the business during a divorce can both become quite contentious matters. It is highly recommended that small business owners enlist not only the assistance of a New Mexico divorce lawyer but also a financial expert or business law attorney.
New Mexico Financial & Family Law can provide you with a confidential, no-obligation consultation regarding your divorce and the handling of your business assets within the divorce decree. Reach out to one of our knowledgeable and experienced attorneys today when you call (505) 503-1637 or contact us online.
Family Businesses Represent a Unique Challenge During Divorce
After marrying, couples run their households like a business. All funds are combined and allocated to meet agreed-upon goals. This unity is why it is possible to file taxes together; In the eyes of the IRS, married couples filing together are considered to be one unit.
However, when a couple chooses to end their marriage, shared family assets face potential disruption. A divorce can be an especially stressful and challenging situation to navigate when a family business is thrown in the middle of it. To complicate matters even further, often family businesses are listed as sole proprietorships or limited partnerships, with no clear division of equity between operators. It is not so easy to arrange a “buyout” of the shares held by one partner or the other. Consequently, it is not uncommon for a family business to be pulled from both ends in the middle of a contentious divorce.
Family businesses are common in the United States, accounting for approximately 64% of the U.S. GDP and providing employment to over 60% of Americans. As a result, family-owned businesses are huge drivers of adding new jobs to the workforce. Additionally, family businesses are known to have transgenerational longevity, meaning they are able to survive more than one generation by fostering the entrepreneurial skills of future family members.
Given how state laws are written, there is an expectation in many divorce situations that the value of family businesses will be split when the marriage dissolves. If one person wants to keep the business in operation after the divorce, they would need to pay about half of the business’s value to their partner or agree to give an equal value in other types of marital property in these situations. Other assets that can be exchanged in place of half the business are cars, houses, stocks, and investment accounts. The value of each share of the business can be subjective depending on each person’s involvement in its operation. The split of the business is not necessarily fifty-fifty but is calculated on what is considered fair.
However, Family Business Magazine states that most family businesses remain shared after separating; usually, this is because each spouse plays a vital role in the business’s operation and success. Also, buying the other person out can be expensive and not worthwhile. Even putting together documents to buy a person out can be costly. Therefore, in many cases, it would be financially disadvantageous to buy a spouse out, making more sense to continue working together.
Whether choosing to sever ties between a divorced spouse and the business or to maintain a business relationship, the dollar-and-cents value of the business will be highly material to divorce outcomes.
Factors That Affect the Valuation of a Business
There are a few things to keep in mind when splitting a family business. Foremost is whether the business is considered a shared marital asset that grows and develops alongside the couple’s relationship. Primary factors in determining whether this is the case include:
- The date the business formed
- Each partner’s financial and labor contributions
- Source of starting funds
- Growth and development of the business from the start of the marriage
- Whether the primary business operator spouse paid themselves a separate salary
- Whether business proceeds and expenses were commingled with household finances
It is challenging not to commingle funds to start a business. Partners often need to make sacrifices of money or assets to leverage their funds to start a family business. Additionally, the nature of the business may have evolved thanks in part to the involvement of the non-primary business operator spouse. For example, if the wife had a business before marrying that grew substantially when her husband became involved, then the husband’s involvement would impact the company’s split.
Apart from funds to start a business, each partner’s contribution in skills is also essential when determining value. For example, one partner was responsible for handling the logistics, while the other was responsible for business development and lead generation. At the time of separation, specific skill sets would be lost that can take time to replace. Likewise, these skills have a dollar value tied to them and affect the company in case of a divorce. In the worst-case scenario, the loss of one skillset could be detrimental to the survivability of the business.
Since these cases are unique and can quickly become complicated, each party is recommended to hire an accountant to estimate the value of the business accordingly.
Consider the Potential Outcomes of Splitting Your Business
In New Mexico, family businesses can have three potential outcomes once a divorce is finalized.
First, one spouse can buy out the other and compensate them for their share.
Option two is for nothing to change regarding ownership. Both spouses, in this case, would remain owners and have the power to make decisions the same as before they separated.
Lastly, the business can be liquidated, and the payout is divided between spouses according to the fairness standard of dividing community property in a divorce.
Avoid Mixing Business with Marital Property
There are ways to protect ownership of the business, but it involves careful planning and discipline.
Before agreeing to marry, business owners or those intending to one day start their own business look for ways to protect it. While consulting with an attorney is the best first step, people must understand that the company’s structure does not truly matter when determining if a business is shared marital property. For example, the family business can be an LLC, a sole proprietorship, or even a partnership, but these structures are less critical compared to the involvement of both spouses and the commingling of household financials. The business’s day-to-day operation or funding determines if it is a marital asset. At some point, people almost inevitably commingle their funds or allow their spouse to play a role in its operation.
There are a few tips to consider when owning a business and deciding to marry:
Be Proactive and Prevent the Commingling of Assets
Even though it takes thorough planning, it is possible to keep business property separate from marriage. Here are a couple of ways to prevent the commingling of family and business income:
- Do not use household income to buy or invest in the business. Instead, keep things in separate banking accounts, and do not use a personal account to fund a business account.
- Pay yourself a regular salary to prevent business income from being involved with household income. Only taking small proceeds could be seen as removing income from the household and instead funneling it to the business, meaning finances have become commingled
- If a spouse works or contributes to the business, lay out terms within a clear contract and pay a fair salary like any regular employee. If it is possible, refrain from allowing your partner to work duties that are outside of their scope of work.
- The growth of the business during the time of marriage is a determining factor. Think of MacKenzie Scott when she divorced Jeff Bezos. Now she is one of the wealthiest women in the world by receiving a quarter of her ex-husband’s shares of Amazon. She was entitled to this as part of their divorce settlement in 2019.
- The date the business formed can matter, but usually, when family businesses begin, the couple is already married. So, while this matters, it is not common to apply in a divorce case.
- Creating a trust or corporation to own the business can help, as long as operations and finances are not significantly commingled with household income.
- Keep work confined to a home office that is not used for anything else rather than using various parts of the household for operations, storage, equipment, etc.
Execute Prenuptial and Postnuptial Arrangements
Prenuptial and postnuptial agreements are an excellent place to start when considering the future protection of a family business. They can help with disagreements in the dissolution of a marriage or if a spouse should pass away or become incapacitated, clearing up what asset would go where in each situation. Additionally, a mutually and consensually signed agreement by both parties may specifically mention assets that are exempted from community property standards.
A prenuptial agreement, also known as a “Prenup,” is a contract both parties sign before entering a marriage. These agreements list each person’s assets and debts and define what would happen during separation. A postnuptial agreement is completed after marrying and serves the same purpose as a prenup but includes assets acquired or earned after marrying.
While discussing these agreements is stigmatized in today’s society, prenups and postnup agreements address issues that could be contentious in the event of separation.
Talk to a New Mexico Divorce Attorney About Your Family Business
In the unfortunate circumstance of a divorce, New Mexico Financial & Family Law can help you discuss your options to protect your family business. Classifying the nature of the family business and settling its possible division are serious matters which can become quite contentious, even during an amicable divorce.
Taking the first steps to separate can be difficult, but having legal representation can make this process easier. Learn how the law can affect your family business by scheduling a no-obligation case review today when you call (505) 503-1637 or contact us online.