Divorce in a Family Business

With the U.S. divorce rate hovering close to 40%,* there’s no doubt that family-owned businesses can feel its effect. But divorce doesn’t necessarily need to spell the end of a family business. It can be difficult to overcome, but proper planning can help alleviate the emotional, financial and operational challenges that can face a family business during a divorce.

Divorce and death are two topics that people usually avoid discussing. It’s no different in a family business. As you’re building your business, you’re busy focusing on a myriad of things. You probably don’t think of divorce planning as an immediate need. While no one wants to think about divorce, it’s always a possibility. Fortunately, there are ways to help family businesses survive a divorce and continue to exist.

Two divorce scenarios

There are typically two scenarios that can unfold in a family business when a divorce takes place. The first is when the two spouses are business owners. They work together to build the business, but when they divorce, financial and operational issues quickly come into play. From a financial perspective, can one owner buy the other owner out? Where would the funding come from? Operationally, can the divorced owners continue to work together in the same environment? Would employees or customers divide their loyalties between one owner or the other? And, how would the business’ succession plan be impacted?

The second scenario doesn’t involve two spouses as owners. Rather, it involves a family business with multiple owners who have spouses that are not active in the business. For example, how would the divorce of one of the owners impact the business? You could easily find yourself in a situation where you could inadvertently get into business with the ex-spouse of your partner, who could lay claim to some of the business’ equity and essentially become a business partner. Do you have the right plan and appropriate assets in place to help prevent this unintended but potential possibility?

In either scenario, you can avoid these challenges during a divorce with proper planning up front.

The business plan

Most critical to the likelihood of your family business continuing after a divorce is having a clear, written business plan in place to address all the questions that could arise. The plan should answer questions like:

• Do we agree to continue the business or give one of the owners the option to buy out the other owner’s business interest?
• If the latter, how would they fund it — through assets immediately available to them, or finance it over time?
• Could they qualify for a loan? How much collateral would they need? And, what percentage of the overall business value would they need for a down payment?

All these discussions, and others, should be integrated into the plan.

If the business includes two or more separate business owners and their disinterested spouses, provisions in the plan should protect the owners from giving up equity in the business to a disinterested party in the event of a divorce. Personal assets, such as life insurance, or investment or savings accounts, are ideal products to use in this scenario to help keep the business viable and its structure in place.

In addition to the valuable death benefit it provides, permanent life insurance is an asset that can be used to help fund a buy-out. In the case of two spouses owning the business, one spouse can use the cash value in their life insurance policy to either buy out the other spouse or cover a down payment in the event of a divorce.

Prenuptial agreements

Having a prenuptial agreement in place protects the interests of both spouses. In its simplest form, a prenup sets guidelines on what either spouse can claim as marital property in the event of a divorce.

For example, Alicia inherits a family business, then gets married to David. She spends five years expanding her family’s business and increasing its value. If they have a prenup in place to protect Alicia’s interest, David can’t lay claim to the value of the business if they divorce.

Operating agreements

An operating agreement is critical to a family business because it is essentially the blueprint for the business. A properly drafted operating agreement will cover vital topics like:

• Who are the owners of the business and what is their ownership percentage?
• What is the total amount of capital contributions they’ve made to the business?
• At certain triggering events, like death, disability, divorce, or sale or transfer of shares, what are the rights of the other owners?
• What is the succession plan, or how will the business be dissolved?
• How will the proceeds of the business be distributed?

Once reviewed, all owners of the business will sign the agreement, but it’s important to keep the agreement up to date. The agreement can be amended at any time, to account for possible future divorces, remarriages and other unforeseen situations. The key is to stay on top of these scenarios and take the time to update the operating agreement when necessary.

A labor of love

Family business owners often refer to their business as a labor of love. While divorce means the end of a marriage, it doesn’t have to mean the end of a business. The right advanced planning can give you the opportunity to protect your business from the sting of a divorce. To learn more about planning for your family business, contact a financial professional today.

These are hypothetical examples used for illustrative purposes only.

This post is for informational purposes only and should not be considered as specific financial, legal or tax advice. Depending on your individual circumstances, the strategies discussed in this presentation may not be appropriate for your situation. Always consult your legal or tax professionals for specific information regarding your individual situation.

*CDC, May 21, 2021 https://www.cdc.gov/nchs/data/dvs/national-marriage-divorce-rates-00-19.pdf

3727094CC_AUG23