When one or both spouses are involved in a business, are executives or have a professional practice, there are various financial issues that may arise. Family lawyer Margaret Joy delves into some of the issues divorcing couples need to be aware of, including valuation and property division, when businesses and practices are involved.
Hosted by: Diana Shepherd, Editorial Director, Divorce Magazine
Guest speaker: Margaret Joy, Family Lawyer at McCarthy, McDonald, Schulberg & Joy
Bio: Practicing family law for over 30 years, Margaret Joy has extensive experience in all aspects of family law and litigation, including the valuation of closely held business interests, stock options, executive compensation, and professional practices. She is the co-founder of the Pittsburgh family law firm McCarthy, McDonald, Schulberg & Joy.
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Read the Transcript of this Podcast Below.
What should a business owner’s first step be after being served with divorce papers?
The first step that a client should take when being served with divorce papers is to consult with an experienced family lawyer. It’s terribly important for the client to understand what the do’s and don’ts are right at the outset to avoid any pitfalls or statements that might prejudice him or her later on in the case. That would be the first suggestion I would have.
The next thing I would suggest is that the client not sign anything that’s proffered to them by the other spouse or by counsel for the other spouse. The only exception to that would be if you get a green card in the mail indicating that you’ve received something from the post office. You can sign that, but other than that, I think it’s not wise for the individual to sign anything that’s being offered to him or her without consulting with counsel.
My third answer would be that it’s probably best not to discuss significant financial matters in detail with the other spouse once you’ve been served with a divorce complaint without getting some advice about that from counsel. I would not want to have anything said that could be used against you later or that might prejudice any arguments we might wish to make, so it would probably be wise to talk to a lawyer first about those issues before trying to have that kind of conversation with your spouse.
What are the most common issues for business owners during and after divorce?
I think that, probably, the first issue on the owner’s mind is maintaining smooth business operations during the process. Obviously, the business owner is greatly invested in having the business continue to be successful and, frankly, the other spouse should also be equally invested in that because that may be the source of income, alimony, and other issues down the road. From the owner’s perspective, he or she wants to make sure that the business will continue to operate smoothly and, hopefully, profitably during the process.
It’s certainly the case that the discovery process, meaning sharing information and documents with the other side, the valuation process for the business that will probably need to be undertaken, and so forth can be disruptive and will certainly be time-consuming for the owner that’s involved in the divorce. One of the purposes of having good counsel work with you on those issues is to make sure that that disruption is minimized, that cooperation is done to the maximum extent possible so that the business can continue to operate in a profitable and positive way. You also need to make sure that the business is stable, it’s continuing to operate, and will not suffer any significant financial detriments from the fact that the spouse is being divorced and so forth.
Another issue that frequently comes up with owners is how co-owners, other owners of the business – whether they be family members or third parties – are going to react to the news that there’s a divorce of an owner, how that will affect them, how that will affect their employee status, their incentive compensation, lots of other issues, and also the financial viability and stability of the business. Those concerns are always forefront in a business owner’s mind. Those are issues that we work on very closely with the client to try to minimize and explain and educate everyone involved as to what is going to happen and that the business will end up being just as productive as it is at the present time.
If one or both spouses own a business, is it always necessary to hire a business valuator? Is there a minimum size or a potential dollar value to make it a worthwhile exercise?
I would say that it’s not always necessary to value a business, but it usually is. It is very often the case that business owners have an agreement among themselves about how a person who is leaving the business – whether it be by death, retirement, or just leaving – would be paid, and those agreements are very important in determining how much a business is worth for purposes of divorce. It is always necessary to apply some sort of value to the business if one spouse is going to keep it, which is almost always the situation. In order to arrive at that value, one has to have a valuation done.
It can be the case, and in a very simple business where there’s a sole proprietorship, just one individual that’s performing services, it may be simple enough that a formal business valuation is not required. In most cases, however, particularly where there are co-owners and more complicated valuation issues involved, it is going to be necessary to have a valuation done. One of the things that divorce counsel helps you with is selecting a business valuation expert to work with. That individual works very closely with the lawyer to arrive at a strategy for valuing the business, gathering the information, and so on, so that, for settlement purposes and, ultimately, if settlement is not possible, for trial purposes, to have a value that is appropriate for the nature and extent of the business interest that the individual has. Particularly where there are other owners and maybe the spouse that we’re dealing with is a minority owner or doesn’t have control, there are certainly lots of issues that come up with that we want to have the business valuation reflect, so it is a wise investment, in most cases, to have a business valued for purposes of a divorce.
When a high-net-worth business owner is preparing for a divorce, do they ever run up the company’s debts or losses to decrease the company’s value?
I won’t say that’s never happened. Certainly, that has happened. That is almost never successful from the standpoint of reducing the value of the business for divorce purposes. I would say two things about that. Number one, it’s the rare business owner who will intentionally tank or diminish the value of his or her business that they’ve spent maybe a lifetime building to gain a better result in a divorce. So number one, it doesn’t happen very often.
Number two, when individuals do attempt to do that, and as I said, it’s not unheard of, that is a very transparent strategy that is easily detected by the other side and, certainly, by the court, so it does not succeed in almost any instance of resulting in a lower business value being attributed to the business. If you intentionally diminish the value of your business, the business will be valued as if you hadn’t done that and will be attributed at that higher value in your column, so that’s really not something I think is frequently seen and, certainly, it’s not frequently successful.
What happens if both spouses hire their own business valuators who come up with wildly different valuations? Does the judge just take an average of the two?
No, certainly not. That’s not the way it works. It is certainly common – in fact, it’s almost routine for both sides to hire business valuation experts. It is done, on occasion, where both sides will agree on a business valuator and agree to be bound by the value that that person comes up with, so that is an option. Most of the time, parties hire their own business valuation experts if the business has any significant value, and it is always the case that the business valuation experts come up with different values.
Business valuation is a very complex undertaking. There are many assumptions that go into that, and the assumptions that can be made have a range of reasonableness, so it’s not a strict formula that everyone uses the exact same formula and comes up with the exact same answer. Just like when you get a house appraised, no two appraisers will come up with the exact same number in almost every instance. They have different comparables and different ways of adjusting for those. Same thing in a business valuation but much more complex.
When the court is presented with two different values, it doesn’t simply take the average of the two. In most instances, it will look at the two valuations, try to determine from the testimony of the experts why they’re different, what factors they assumed differently, and the court will make a decision about which is more reasonable given the various differences that they have. The same process happens in settlement discussion, so if I have a value of X and the other side has a value of Y, we try to understand the three, or four, or five issues that caused that difference and try to either compromise them or understand whose arguments may be stronger on this issue or that issue and come up with an overall value that everyone can agree with. If agreement can’t happen, that is really what the court does. They look at the various issues and try to decide which value makes the most sense.
How can a business owner protect their company during divorce, both financially and from unnecessary disruption from the other side’s attorney?
Again, I go back the first question, which is hiring competent counsel. I really don’t mean for that to sound self-serving, but it is very important, particularly for a business owner, to have good, experienced family law counsel who is experienced in dealing with self-employed individuals to guide the client through that process. As I said earlier, one of the goals is to minimize the disruption and time involvement of the client to the maximum extent possible.
One way to do that is to make sure that the business owner client cooperated fully with the discovery requests of the other side. By that, I mean when the other side asks for documents, information, etc., it’s usually the best strategy to provide that as freely and willingly as is possible, subject to a reasonableness standard, obviously, in order to avoid a very time-consuming and disruptive litigation process where they have to try to extract the documents from the business owner. That tends to provide more disruption, more cost, more hassle than it’s usually worth, so cooperating with the other side and providing relevant information is certainly important.
It’s also important, I think, for the business owner to have his or her attorney explain in detail what the process is, what the likely timeline is, what the likely costs are, and what the possible outcomes are. That’s what we do. We try to educate the clients about those things so that informed decisions can be made. Informed decisions minimize disruption and mental stress, which is very, very important, particularly for business owners who have many other things on their plate.
Many high-net-worth clients have an ownership interest in a family or closely held business. If a non-family spouse becomes employed in a closely held business, what might be some of the problems that might occur if the marriage breaks down?
This is a fairly frequently encountered scenario where, just to take an example, the husband is an owner of the business and runs the business, but the wife is an important employee of the business. That’s not uncommonly seen, and it does present some additional problems. If there’s going to be a divorce, in the vast majority of cases, the non-owner spouse in my example, the wife, is going to have to be let go from her employment position. There are rare occasions where ex-spouses can continue to operate in business together, but in my experience, that’s pretty unusual.
In the normal experience, the wife or the employee spouse has to be let go, and that presents problems from the standpoint of, obviously, her income being decreased or having to find another job. The other issues that arise are there can be more disruption if you have a spouse directly involved in a business where there’s a divorce going on than if the spouse is not involved in the business. She might have much greater access to information. You might have security issues. You might have employees taking sides, that sort of thing that can be complicating in terms of negotiating both a financial divorce and a personal divorce, so all of those things have to be addressed.
Again, a counsel can certainly help in working through those issues and understanding how they affect the financial aspects of the case. For example, if a spouse is no longer going to have a job at the business and her income is going to be reduced as a result, how does that affect your support obligation both short term and longer term? So there are some fallout issues or secondary issues that arise from that kind of a situation that need to be addressed, which we try to help with.
How do you split a business owned and operated by one spouse? If the business has been in that spouse’s family for generations, is it exempt from division during divorce?
No, it’s not. If a business was initially acquired by the spouse during the marriage, it is a marital asset unless it was acquired by gift or inheritance. So if you have a situation where, let’s again take an example, husband is the owner of the business and he received that ownership interest from his father, who gave it to him upon the father’s retirement, that asset is a non-marital asset. However, the increase in value of that asset during the marriage is going to be part of the marital estate, so there is always a component of the business value that would be considered in the marital estate, and it has to be valued, as we discussed earlier, by a business valuation expert.
The other spouse, then, has to receive other assets to compensate him or her for the fact that the owner spouse is retaining the business. Businesses are almost never split in kind where each spouse would end up owning a share of the business. That’s almost never done, I would say really never done. The owner’s going to keep the business, and the other spouse is going to get something else to compensate.
In cases where one spouse has a professional practice, a lawyer or a medical professional, for example, will it be divided on divorce, and how would that work?
No. Professional practices are never divided. In fact, in most instances, they cannot be divided, so law practices, medical practices cannot be awarded partly to the lawyer or medical professional and partly to the other spouse. Clients or patients cannot be assigned to somebody that they didn’t choose, so just like any other business, those types of businesses are always awarded to the spouse who’s the owner or, in this case, the professional, and the other spouse is awarded other assets to compensate for the value of that. The valuation of professional practices has a special component to it that’s a little bit complex called goodwill, which is something that we also address in business valuations, particularly with regard to professional practices.
How do you value a cash-based business when you suspect the owner spouse is not declaring some or even most of their income?
This also is a fairly frequently seen scenario, and there are certain types of businesses that are more prone to that, restaurants, hair salons, people that do deal in cash, and there certainly are other types of businesses where cash is a factor. Forensic accountants are often hired to address those issues and to trace business receipts, expenses, people running personal expenses though their business, and things of that sort. Those forensic accountants are often the same people that do business valuation, so it’s a very handy package to hire someone who is able to do both of those kinds of tasks if that’s appropriate for the particular business. We do that quite frequently, and there are lots of ways to try to ascertain the extent of cash transactions or other sorts of hidden value that an owner may be participating in, either directly intentionally to limit the size of the marital estate or simply as a matter of longstanding business practice. In either case, we need to include that value in the marital estate, and we have experts that are able to help the lawyers do that.