How To Avoid Roadblocks In A Family Business When There Is A Divorce

Have you observed family businesses, especially those that are owned and run by married couples? In many cases, such couples have to deal with personal obstacles that can overshadow the business management. These obstacles are often the result of the close relationships between family and business finances.

Although experts suggest family bonds are essential for such enterprises to succeed, they usually face challenges. As such, what can keep the business running in case of an emotionally charged divorce? Well, the answer lies in crafting a contractual agreement.

How to deal with roadblocks in a divorce-rocked family business

When a married couple jointly owns and operates a business, the enterprise's fate must be decided when a divorce happens. In this situation, the contractual terms put in place from the outset will determine the ownership and management decisions. The contract, commonly known as a shareholder, partnership, or member agreement, usually guides shareholders' relationship and defines their rights and roles.

Signing the shareholder contract is the only fool-proof solution to operate the business successfully. With it, the couple can permanently protect the business. It involves reaching an agreement on all company assets. For legal reasons, a court judge must preside over the enforcement of the agreement's terms. This includes directing the operation and ownership of the business. A couple can ensure a sense of predictability for the business, regardless of how volatile the personal situation gets.

While drafting the shareholder agreement, the couple should include specific protective provisions. For instance, they can agree that if a separation or divorce occurs, it might call for a compulsory buy out of one of the spouses' interests. It's essential to incorporate a clear roadmap for valuing the departing spouse's share. If there are insufficient funds to initiate the buyout, the parties can consider other alternatives to finance the buyout.

Ultimately, to determine the value of what the departing spouse in the business gets, the couple can set a pre-agreed formula. As a suggestion, the procedure can fix a set price involving an independent third party. The agreement should include the specific conditions under which the third party can buy the departing spouse's business interests.

Sign a prenuptial or postnuptial agreement

A prenuptial agreement refers to an agreement reached by two people before they get married. Such contracts often cover property rights and assets. It can effectively protect the business during a divorce. If you don't want your partner to benefit from the family business after a divorce, you shouldn't hesitate to include a well-defined provision in the prenuptial agreement.

In a prenuptial agreement, the couple generally agrees on the division of business interests. This action can insulate the parties from costly legal processes. The two parties need to decide on how they will share the business assets. For instance, if one party keeps the business, the other is entitled to a buyout. From the outset, the parties should establish the assets' value and agree on the buyout formula. However, note that any appreciation in the business value gained during the marriage is always subject to division. The couple can treat this appreciation as separate premarital property. Thus, the sharing of such assets is subject to negotiation between the parties.

Alternatively, a couple may opt for a postnuptial agreement. This is similar to a prenuptial -- only that the contract is signed after the wedding. Although judges are often skeptical about postnuptial deals, they are essential in determining a business's value as separate property. A couple should complete a postnuptial agreement well before the marriage gets into problems (some suggest at most seven years into a marriage).

The perils of shunning a shareholder contract or a prenuptial agreement

If the parties did not sign a shareholder contract or a prenuptial agreement, they might go through a messy court process. Ordinarily, the judge will consider the family business as marital property; this will be the case even if only one of the spouses currently owns it. The judge will likely view public policy to determine such family assets' division based on equitable principles.

Interestingly, the courts are generally hesitant to order couples to remain in a business partnership after a divorce. Ultimately, the one who can prove competency in running the business is the one who's likely to retain ownership. The other will either be paid in cash for their share in the business or get a note payable over ten years. The couple can secure this note by business assets. Sometimes, a financial institution may place a lien against the business's equity interests until paid in full.

Alternatively, the couple can place the business in trust. This way, it exists as a separate entity and isn't viewed as marital property. This is the surest way to protect the company from the undesirable effects of a divorce. Note that while these provisions relate to closely-held family businesses, buyout provisions can occur due to a divorce, a deadlock between the owners, a conviction of a felony, or after the death of a spouse.

Final thoughts

Married couples who run a joint business should take time to sign the requisite contracts. Doing this can work well to secure their business in case they go through a divorce. There are several types of agreements that couples can choose from. These include prenuptial or postnuptial agreements; yes, to keep the business going long after a divorce or separation, the parties must take such thoughtful and conclusive actions well in advance.