If you own a business, you are used to tracking various risk variables, such as new competitors, technological changes, or procurement costs. But have you seen your spouse as a potential downside danger?
Think about it: Divorce is not an unpredictable “black swan” event. Almost half of first marriages end in court; the share is even higher for second and third marriages.
Couples who own a family business may have got together when they were young, and the business was probably of little value. As the business grows over the years, it’s not uncommon for a couple to have almost all of their net worth tied to the business. As a result, there is usually not enough money for one spouse to redeem the other.
This can mean that the business has to be sold or go into heavy debt, even if the business has been built and managed over the years by a single spouse.
Thus, protecting your family business from the consequences of divorce is crucial for its survival. And for many couples, the business is each partner’s greatest personal asset.
Here are some mechanisms to use:
A marriage contract now will save your business later
Of course, if you started the business before your marriage, you can sign a prenuptial agreement that specifies what happens to the business if you divorce.
Done well, marriage contracts can be foolproof, even overriding property division laws in the nine community property states: Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin. .
The document must be written and performed voluntarily in the presence of witnesses. This requires full disclosure by both spouses and cannot be “unreasonable”. That means if you’re making millions, you can’t just give your spouse the Keurig and a goodbye kiss.
For people who renounce a marriage contract, before marriage is also the best time to put in place a buyout agreement to protect a family business from disintegration during a divorce. Also known as a buy-out agreement, a buy-sell contract is a contract between business co-owners that governs the situation if one of the co-owners dies or is otherwise forced, or elects, to leave the business. .
In the event of a divorce, a good buy-sell agreement would require an ex-spouse to sell any interest received in a settlement to the owners of the business at a price set by a specified valuation method.
Using a Generational Wealth Trust
One way to protect the assets of the family business over the long term is to use a trust to protect the next generation in case that generation goes through a divorce.
For example, a father donates $ 5 million in shares of the family business to his daughter, which is placed in a trust that only benefits her. If she marries and divorces later, her spouse cannot touch that money, as long as the shares offered or the proceeds from the sale of shares remain in the trust.
This type of trust is favored in situations where net worth is high, but in general, it cannot be used to prevent a business divorce if you and your spouse separate.
Stay together, at least in business
Perhaps the best and easiest way to structure a business that can withstand divorce is for spouses to remain co-owners, even if they divorce. Unfortunately, this strategy will not work for many couples, especially those locked in an emotional or legal fight.
If you go this route, however, make sure you have a shareholders’ agreement that gives one spouse the right to buy out the other at a mutually acceptable price.
Note that buying your spouse’s stake in the business first requires assessing the value of the business, which is not always easy and can in itself be very costly. Finding the money to fund the buyout can also be difficult.
You can use leverage to raise funds, that is, adding debts to the business to get money for the spouse who will no longer be involved in the business.
Borrow, redeem or add a partner
The best way to do this is to take out a bank loan; it’s easy and will likely have the lowest cost of capital.
Another option is a property settlement note, which is a long-term loan for a payment with interest of the amount you owe your ex-spouse for his or her share of the business.
If the business already has significant debt, you may want to consider adding a partner or looking for a private equity or venture capital investment. If you choose to add a partner, be sure to include a buy-sell agreement in the agreement.
Finally, selling the business and sharing the profits is a simple, if not ideal, solution. And if your business represents the largest share of your assets, this may be your only choice. One advantage is that if your business sells quickly, you will both soon have money to pursue your own interests. In addition, selling the business allows you to avoid financial ties with your ex-spouse. But keep in mind that many businesses are not easy to sell, so you might have to work with your ex for many months.
But who knows? You can work it out and get remarried. If so, this time, please see above on prenuptial agreements.
Daniel Thompson is a Certified Financial Planner and Regional President of First Western Trust in Denver.