When one or both spouses own a business, there are many issues that may arise during the divorce process. A family lawyer will work with different professionals, such a business valuator or forensic accountant, to determine how much a business is worth, how it will be divided, and how it will affect child custody and spousal support. Oregon family lawyer and mediator Laura Schantz provides answers to some of the most common questions business owners have when going through a divorce.
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Divorce Magazine Podcast: Beaverton, Oregon Family Lawyer on Divorce Issues When a Business is Involved
Hosted by: Diana Shepherd, Editorial Director, Divorce Magazine
Guest speaker: Laura Schantz, Family Lawyer & Mediator
Laura Schantz, who is the founder of Schantz Law in Beaverton, Oregon, has more than 20 years of experience representing clients with higher assets and unique issues. Laura knows the business side of family law, and her firm has extensive experience with those who work at Intel or other high-tech companies. She has helped clients find creative solutions to complex financial matters involving asset division, dividing farm property, spousal support, and child support. For more information about Laura and her law firm, visit www.oregondivorceattorney.com.
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What should a business owner’s first step be after being served with divorce papers?
It’s the same for everybody. Take a deep breath and realize that a divorce is a marathon, not a sprint. That’s one of the things that I tell almost all of my clients. But particularly for business owners, I think that getting organized with your business bookkeeping is something that I’ve seen cause problems in many business valuation cases. I’ve had cases where people haven’t completed their taxes for many, many years. I’ve had cases where the bookkeeping is just in very bad shape, and it takes a lot of work to get it into shape just to figure out what’s going on with the business. The first step would probably be to get your bookkeeping up to date, to get your QuickBooks up to date, and get your taxes up to date; that will put you in a good position to move forward with a divorce when there is a business involved.
How can a business owner protect their company during divorce, both financially and from unnecessary disruption from the other side’s attorney?
When you talk about financially, I think that’s just wanting to keep the organization going and making money. It might make some sense to designate a person – either maybe a new person that you hire or someone within the organization – that can be in charge of gathering the documents that are going to be requested by the opposing party to the divorce case, their accountant, or a business appraiser. Because you want the business to keep running and doing what it does best, and you don’t want to have to shut down the business because you have a lot of gathering of documents to do, I would suggest finding someone to be in charge of that part of it.
If both spouses co-own a business together, how will it be divided after divorce?
It really depends. In the last couple of years, I have had a case with a couple who were veterinarians, and they both owned and ran this veterinarian practice. You are sitting there wondering who is going to leave and who is going to stay. When you get a divorce, you’re going to disentangle the parties completely and financially. It’s very unlikely that someone would stay working in the business. But in that case, one of the parties was going to have to buy the other person out of the value of the veterinary practice. It just sort of shook out that one of them decided they were going to be the one that could do that, could stay in the business, could do the work, and could buy the other person out. The other person was willing to look into working somewhere else, maybe starting their own business in another location. That sort of worked itself out.
Normally, though, there’s always one person that’s really the primary person in the business. It’s the family-owned business that’s been a timber company in the family for generations, or somebody is doing most of the work but the other person is just doing the bookkeeping. Typically, the owner that’s the most involved is going to be the one that’s going to end up staying.
What happens in a case where valuation of a family farm is needed? For example, when one spouse wants to continue to run the farm but the other wants to sell it to a housing developer?
I had a farm case like that very recently, and it had just those issues where my client was a peach farmer and he wanted to continue farming. His wife was going to take part of the land and be the one in charge of developing it. In most of the farm cases that I have had, there are multiple parcels of land. What we typically do in a divorce situation is we divide up the parcels of land. A lot of times, one of the people, let’s say it’s the farmer husband, has had the land in his family for generations. It’s tough. It’s kind of gut wrenching for that farmer to have to divide up land that has been in his family for generations.
Typically, if they have children together, the thought would be that the spouse – the wife – would eventually, when she passes, give the property back to the children, and it would be back in the family. That’s one kind of silver lining. In terms of valuing land for development in that case, it takes a lot of money to develop farmland. There was a road in that case that needed to be built before anyone would consider purchasing this property as a developed property. That road itself was going to cost $1,000,000. We ended up valuing the property as it was right then and there because that’s what the value was. There was going to be a lot of expense put into getting that land ready for development.
The farmer was able to keep the major parcels that his peach farm was on. I think we got a very good solution for that family. Obviously, every case is different. But it sort of depends on development of how far along are you in the process and what kinds of costs are there going to be going forward when you talk about how we’re going to value this property.
If a self-employed spouse like a software developer or a farmer, for example, is going through a divorce, are they going to get their share of the value of the business?
They would be getting their share if there is a value to the business. Are they going to get spousal support? If spousal support is an issue in the case because one of the parties doesn’t work or was working in the business and has to restart, they would get spousal support. There are a variety of factors that go into thinking about whether there is value to the business.
How can you be sure that the spouse who has a cash-based business is telling you the truth about profits and losses and how much it actually brings in?
That’s very difficult. A lot of businesses are either cash-based or the books are not really that accurate, and you’re going to have to go into the tax return and look at the deductions and sort of add back in things like depreciation, car expenses, and who knows what. You’re really going to have to get a forensic accountant who is going to look really carefully at deductions that are being taken from the income of the business.
I’ve had forensic accountants go and look at bank statements for years and years because there was so much cash that there was hardly any income showing up on tax returns. Yet, there were thousands and thousands of dollars going through chequing accounts. At least this person put it in the bank so that you can find a stream of income that’s higher than what is reported on the tax returns.
How is spousal support determined in divorce cases that involve a business?
Spousal support is based on, in any case, the income of both of the parties. The first thing is are both parties working? Is one party making more money than the other person? Those types of factors. That’s going to be the same in any case. But when it involves a business, you have to look at the two different things: One of them is the stream of income that the business produces that could be used to pay spousal support. The other one is can that person also receive one half of the value of the business. Does the business have any value? There are two different things that the spouse is entitled to: the value of the business and potentially spousal support from the stream of income.
Is the business taken into account when it comes time for calculating child support? For example, if the teenage children are driving company cars, have company cell phones, or may have been earning money from the company.
In that situation, what you would be doing is potentially adding back in the cell phone, the car, and that kind of thing, and then adding that to the wage earner’s income. Then you want to make sure that child support is calculated on that higher income.
a)What does “double dipping” mean in a divorce context?
You’ve got a marital asset which is the business, and the business has a value. You’re counting that marital asset as property in the division of all of the property in the divorce case. You’re counting it once, and then you’re wanting spousal support, so you’re counting the business again because it has a stream of income that it produces. Then you’re using that to provide spousal support to one of the parties. That can be double dipping, where you’re valuing the business, giving the spouse half of the value, plus valuing the stream of income from that same business and giving that spouse spousal support.
b)Why would this be a problem?
The problem is that it really goes to the way that the business valuator is getting a value for the business. Typically, if a business really has value, that means that there is a certain amount of money that’s flowing to the owner that’s over and above what we call “reasonable compensation.” You kind of look at the industry like a veterinarian. You say, “What does a normal veterinarian make if I went out to get a job as a veterinarian?” You can kind of figure that out. Your business appraiser says, “Well, if I went out to get a job as a veterinarian, I could make $150,000 a year.”
But then you look at the veterinary business. Let’s say in this veterinary business, the owners were making $300,000 a year each, which was actually the case in my case. That’s what’s called excess earnings. To be very careful not to double dip, you either have to only provide spousal support based on a normal compensation for a veterinarian or you have to only value the business based on a normal compensation for a veterinarian and not use the excess earnings. You can use the excess earnings for spousal support, or you could use the excess earnings to value the business, but you can’t use them for both because that’s what causes double dipping.
If one or both spouses own a business, is it always necessary to hire a business valuator?
You can have a business where somebody is a landscaper, and he goes around, has all these customers, and landscapes their yards, and they love them and he’s their best friend. Is somebody going to buy that business from him and pay anything for it, because my question to my client is if he steps out of that business, would there be anything there to buy? Maybe he’s got some goodwill. Maybe he’s got some name for his landscaping business, and maybe he could tell all these customers, “Hey, Joe the guy who is buying my business is great. Use him.” Maybe there would be something there.
There might be a value when the business gets bigger. There’s value when there’s goodwill, meaning you could transfer this business and people wouldn’t really care that the owner or the main person wasn’t involved anymore.
When there’s this excess earning where somebody could think, Wow, if I buy this business, I’m going to make more than a normal person in my position would make. I have a lot more earning potential, what I like to do is take a quick look with an accountant to save my client some money and see if there are excess earnings or goodwill. The accountant, a good accountant who may also be a business appraiser, will do that for a fairly inexpensive cost, $1,000 or $2,000. If the accountant says, “Yes, I see something here, I see some excess earnings, I see some goodwill,” then it may be prudent and necessary to hire a business valuator.
To save money, can a business owner use the company’s accountant, who is already very familiar with the business, to value that business instead of hiring an outside professional?
If both parties agree, yes. I had a case recently where the parties agreed to use the business accountant and the accountant came up with an amount of value for the business. Then one of the parties said, “Well I don’t like that number.” Then they hired a business appraiser. If both parties agree with the number that the accountant comes up with, then that is definitely a nice, inexpensive way to get a value for the business. But if somebody doesn’t like that number, then you’re going to have to hire a business appraiser.
Is there any point in hiring a financial professional if the self-employed or business owner’s spouse is not being co-operative about producing records?
Yes. As an attorney, you have to do your due diligence. You can’t let someone get away with not being co-operative. I’ve had my forensic accountant and/or business appraiser tromping around on site, at whatever the location is, going through boxes and boxes of badly organized documents searching for the information that he needed to value this business. If that’s what it takes, that’s what you have to do. You also can use a motion to compel production of documents and force the business owner with a judge telling him that he must produce these certain documents by a certain day. That’s something that we use as a last resort.
Often times, and almost every time, the business appraiser is going to want to have the complete QuickBooks files digitally sent to them with the password, and that’s very normal. That’s the best information for that business appraiser to have. That’s the easiest way to get the appraisal going.