In divorce cases involving a business or a spouse who is an executive at a large company, both spouses will be seeking their fair share of assets. In this podcast, Chuck Roberts – a DuPage County divorce attorney – discusses what couples can expect as they go through the divorce process. He outlines some of the issues that may come up during a divorce involving a business, what you need to know about business valuation – including what and who is involved in the process – and what both parties can expect following a divorce.
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Hosted by: Diana Shepherd, Editorial Director, Divorce Magazine
Guest speaker: Chuck Roberts, Divorce Lawyer
Chuck Roberts is a family law and divorce attorney and a partner at Momkus McCluskey Roberts LLC, an Illinois-based family law firm. With more than 30 years of experience in family law, Roberts has gained a reputation for his ability to represent clients in high-stakes divorce cases that often involve significant assets and businesses. To learn more about Roberts and his firm, visit www.momlaw.com.
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Read the Transcript of this Podcast Below.
A spouse who owns a number of businesses is about to divorce is concerned that they’re not going to get their fair share. That one spouse looks after the business and the other spouse hasn’t had an involvement in the business. What should that spouse, who’s concerned about getting their fair share, do?
We face that issue all the time in our practice. It’s a situation where the spouse who is less familiar with the business enterprises is going to really need some professional help in order to successfully get through the system. That means, at a minimum, that they’re going to need to retain a lawyer who’s well-versed in the concept of business valuation. The business valuation is going to include assembling records. That means that the tax returns are going to have to be produced by the other spouse. They’re going to review bank statements, financial statements and the like, and documentary evidence of the level of sales and the expenditures that are made from the business.
It’s almost inevitably going to include a valuation expert, and oftentimes that person is a Certified Public Accountant who has additional credentials beyond their CPA that enable them to actually conduct a business valuation. That expert will review the documents that have been assembled, conduct some interviews with the principals of the business, apply certain valuation methodology, and ultimately determine what the actual value is. Without knowing what the true value of the business is, it isn’t possible to get your fair share. It’s very necessary in the context of a divorce to do that correctly, do it appropriately, and do it with people who are well-experienced in that area of the law.
Is there something or anything that a spouse who is actively involved in the business can do to protect themselves from interference from their spouse and their lawyer?
When they’re represented by a lawyer who’s appropriately skilled, the attorney can keep the interference with the business down to really a minimum. The document assembly that we talked about is going to have to be undertaken, but that can be done in a way that is not disruptive to the business whatsoever. The business valuation experts may conduct what’s called a “management interview,” where the expert is allowed to ask questions of the person who operates or owns the business, which can sometimes take two or three hours but is not overly disruptive. That can be scheduled at a time and a place which is convenient for everyone who’s involved. Beyond that, there isn’t really much interference in the operation of the business. The rest of the work actually happens behind the scenes and is not disruptive to the business activities.
What happens if one of the spouses is an executive working for a firm and they have stock options at their work? Are those considered an asset to be divided during the divorce?
Yes. The current state of the law in Illinois is that those types of options are considered and are divided by the court. The options will be divided if and when exercised by the person who holds them. I’d say it’s a routine matter, and as long as your attorney has been through that process before, that’s not overly challenging.
What happens if somebody suspects that their spouse is hiding information regarding the family business or hiding assets, like assets from the family business, as well?
I’ll tell you where we run into that sometimes. One spouse will say, “You know, I think that the other spouse has been taking money out of the business and not reporting it.” That can be a very challenging situation. The lawyer’s first question is going to be, have you filed joint federal income tax returns? At the time that you file those joint returns, did you suspect or were you aware that your spouse was not declaring all of their income? When faced with that kind of situation, that’s a fairly sophisticated manner. It’s going to require some advice from a tax professional. Presumably, your divorce lawyer is going to be able to put you in contact with a CPA who has been through that issue, who knows how to address that with the IRS, who knows how to resolve it in a way that avoids hopefully any kind of adverse consequences to the innocent spouse.
What happens in a case where a spouse gets income that isn’t reported? How does a person get their fair share of that?
That’s a little bit more difficult. That sometimes needs to be offset rather than specifically dealt with as unreported income. It may be offset within a word of other assets in the division of the marital estate to compensate the spouse who has not acted in that reckless manner.
What happens if, in a business, there’s normally an accountant there? Could they not just simply do the valuation themselves?
I probably hear that weekly. Someone will say, “You know, we could just use the company accountant and they should be able to give us a ballpark idea of what the business is worth.” That’s usually really a bad idea. The business accountant is certainly skilled in terms of preparing financial statements, skilled in terms of preparing the tax returns for the business enterprise, but generally accountants are not equipped to do that kind of valuation work. It takes additional skill and training to be able to do valuations, and it’s important to both sides to have someone who doesn’t have any stake in the outcome, someone who doesn’t have a horse in the contest and have a need to protect the accuracy of the financial statements that have been generated.
A business valuation, when it’s done correctly, is going to cost some money. It doesn’t necessarily have to cost an outlandish amount, but generally speaking, it’s a good investment for both sides to have an outside business valuation expert review the documents, conduct the management interview, and formulate opinions of value that will be acceptable to the court that don’t have any kind of contamination from prior experiences with the business enterprise. In virtually every case where there is a significant business, we strongly encourage clients to use outside business valuation experts.
Is there anything more that you want to say about what a business valuator does to come up with the numbers? Is it just one method of figuring out the value of a business, or do they have a number of different ways to go about figuring it out?
It depends on the nature of the business enterprise itself as to what ultimately is going to be the appropriate mechanism to come up with an opinion of value. In almost every situation, we see business valuation experts consider maybe five, six, maybe seven different methodologies. They’ll consider each one. Their written report is going to articulate the different methodologies that were considered, explain why those methods were either a good choice or a bad choice or appropriate or they didn’t fit, and will set forth ultimately the valuation model that was used.
What we’re trying to get to with the valuation effort is come up with a fair cash market value with a business enterprise. That’s often described as the amount of money that a willing buyer would pay a willing seller in an arm-sling situation where neither side is operating under any kind of compulsion or duress. That means, what’s the fair value of it? Not a value for sale purposes or value strictly for divorce purposes, but the actual fair cash market value of the interest that’s owned by the family unit.
What effect might divorce have on the family business? Do people normally end up selling the business as a result of their divorce?
Generally speaking, my experience is that the divorce does not result in liquidating the family business. Generally speaking, and obviously there are exceptions to this, the person who’s operated the business in the past will continue to operate the business in the future. The divorce lawyer’s obligation is to help the parties reach an opinion of value as to what that business interest is really worth and to structure compensation to the spouse who is not going to receive the business for their interest. That could mean periodic payments, it could mean a share of the profits in the future, it could mean a portion adjusted over time as the business profitability fluctuates. There’s a number of different ways that we set that up, but in the vast majority of cases, the businesses have represented the livelihood for the parties. It wouldn’t make any sense to liquidate that interest and leave the parties without any source of income. So generally speaking, we try to find a way to structure it so that the person who has operated it can continue to operate it.
Are the business assets divided during the divorce or is it, I’ll get the business, you get the house, and that’s the way it normally works out?
It’s much more common for one side to take the business interest and the other side to receive an offsetting distribution of other assets. As you put it, maybe one side does get the business and the other side gets the house. Maybe there’s retirement money that can be apportioned disproportionately to compensate the spouse who didn’t receive the business for the interest that they’re foregoing. There’s lots of ways that we are able to structure that. It’s important that the spouse who’s going to continue to operate the businesses is not overly burdened with the payments. We want to make sure that the business flourishes, that the spouse who’s going to operate the businesses has incentive to make it as profitable as possible and to continue that long into the future.
Is it just experience that helps you determine which is the best way to value the person’s business?
It is. Principally, that’s going to come from the business valuation expert. They will open up the toolkit and they have a number of different approaches that can be used. They’ll consider all of those approaches depending on the type of business and ultimately select the one that that gives them the most comfort level as to helping us understand exactly what the value of that business is. Generally, we’re going to see all of the different approaches that are available applied and ultimately the best one will be selected by the valuation expert.
What happens in the case where you’re deciding the value for a business that’s agreed upon by you, the other attorney, and the spouses, and then the divorce decree is finalized six months later after the valuation but the business has suffered and has gone down in value. Is an adjustment made at that time?
It depends on how the deal was negotiated. We frequently will include provisions in the payout provision to take those kinds of circumstances into account. Small fluctuations generally are not the subject of modifications, but a large fluctuation – for example, a new competition comes to town in this family business and suddenly revenues go down by 50% – can be. If you’ve based the payout to the other spouse at the former sales level, certainly it’s not going to be realistic that those same levels of payments can be maintained after a 50% decline in sales. We try to build in some kind of protection for both sides. The small fluctuations are not taken into account, but a significant deviation does need to result in some kind of an adjustment. It might mean that the payments are reduced and continue for a longer period of time, so the same amount of dollars ultimately changes hands but the payment structure is modified.
Has knowledge helped you help business owners who are going through divorce?
It has helped tremendously. I think by hiring a lawyer who has a fair amount of business experience to represent you in your divorce – both advising businesses, I sit on the board of directors of some businesses and represent some corporations in non-divorce context, and having a keen understanding of how the business climate works – can help tremendously when it comes time to, first of all, value that business enterprise in the context of a divorce, and then ultimately determine or make recommendations as to how we can divide it up, how we can protect the level of income and the standard of living that the family has enjoyed in the past when they used to have enough money to maintain one household. Now we’ve got to use that same amount of money to maintain two. Those are sophisticated, high-level considerations, and I believe having a lawyer who has a good business sense in addition to being a divorce lawyer is certainly an added advantage.