New business partners and newlyweds often share the same wide-eyed optimism: Nothing could ever come between this perfect union. Unfortunately, almost 50 percent of marriages fail. Business partnerships are also fraught with conflict and disputes, but have you considered the impact a business partner’s divorce might have on your shared livelihood?
In Texas, as with many other states, assets and liabilities acquired during the course of a marriage are presumed to be community property owned equally by both spouses. In divorce, this community property is subject to equitable distribution – which means split in some manner that is equitable, not necessarily 50/50.
When your business partner divorces a spouse, they will need to characterize their ownership interest in your business as community property, separate property, or a little of both. For example:
- A business established after the date of marriage is presumed to be marital property subject to division in divorce. It’s the owning spouse’s burden to prove otherwise.
- While separate property is generally that which was owned prior to marriage, or obtained during marriage as a gift or inheritance, even businesses started before marriage can become quasi-community property. This is particularly true when businesses were maintained during a marriage and used to support the family, a spouse contributed to the business in some way, and / or its value appreciated. Most Texas divorce cases consider the value of a business or professional practice community property for these reasons.
Dividing business interests in a divorce can be a cumbersome process that requires the separating spouses to properly value the business, determine the correct individual and community property shares, account for appreciation, and in some cases allocate debts and obligations to satisfy loans or fulfill other financial commitments.
It can also require your business partner to reach some sort of agreement with her of his spouse on whether to share ownership interests after the divorce, sell their ownership interest and divide the profit, or have one spouse buy-out the other’s community property share.
If any of that sounds like it could have radical consequences on your business, you are right – it can. The good news is that there are ways to effectively safeguard your business and prevent a business partner’s personal divorce from being overly disruptive or debilitating to the bottom line.
Divorce-Proofing Your Business
A few preventative measures can go a long way in shielding your business from a partner’s marital issues. There is no way to completely negate the risk of disputes or litigation as a result of a partner’s divorce but taking precautions now could lessen the time and expense spent defending claims against the business.
Business partners with spouses should consider these preventative measures:
- Make sure business formation documents address what happens in the event of a partner’s divorce, death, disability, and retirement.
- Maintain good financial records.
- Keep personal and business accounts separate. Do not borrow from personal assets to fund the business, and vice versa.
- You and your business partner should pay yourselves a competitive salary. Otherwise, a good divorce attorney will make the case that more of the business assets should be designated as marital property.
- Sign a prenuptial (or an early postnuptial) agreement.
Beyond these personal and financial measures, there are other legal measures you can take to protect business assets from a personal disruption, beginning with a sound operating agreement that includes a buy-sell agreement.
How Buy-Sell Agreements Can Protect Your Business if Your Partner Gets Divorced
Here is preventive measure #6: If your business has one or more partners, you need a buy-sell agreement.
Something like a business prenup, buy-sell agreements define what happens to a business should any owner’s status change, such as when an owner leaves, retires, becomes inactive or disabled, files for bankruptcy, or gets a divorce.
In the case of divorce, which creates the possibility of a partner’s former spouse receiving a portion of the business or shares of company stock, a clear and enforceable buy-sell agreement can establish ownership limitations to ensure partners don’t end up with a partner they don’t want. This can include:
- Giving other partners the first right to buy any interest / share awarded to a partner’s former spouse at a low, pre-established price.
- Limiting a former spouse’s ability to acquire ownership and requiring them to sell their interest back to the business; and
- Requiring a former spouse to relinquish their voting rights.
Partners’ spouses must consent to any spousal clauses, usually through a signed joinder to the operating agreement.
In addition to outlining what happens when unexpected (though planned for) events arise, buy-sell agreements should also establish the method of valuation that will be used. By agreeing upon valuation methodology in advance, you can greatly reduce risks for disputes between partners or shareholders involving parties that push for valuations most favorable to their positions.
Buy-sell agreements are an essential component of any comprehensive partnership agreement, but they must be carefully crafted to ensure they are clear, binding, and enforceable. At Hendershot Cowart P.C., we help entrepreneurs, partners, shareholders, and business professionals in a range industries establish and preserve the essential agreements that protect their businesses. To speak with a lawyer about yours, contact us.