How to Protect Your Business in a Divorce

When people get married, they always hope for 'happily ever after,' but the sad fact is that 52 percent of all first marriages and 70 percent of second and third marriages end in divorce. Although divorces are always difficult for everyone involved, they can become that much more arduous when one or both spouses own a business.

Your business is probably the most valuable financial asset you own. You've spent countless hours and resources nurturing and growing it. But did you know that you might be unwittingly doing things that could put your business at risk in the event of a future divorce?

Depending on your individual circumstances, your spouse may be entitled to as much as 50 percent of your business in a divorce. Since it's probably safe to assume that you will not want your ex-spouse to remain in your life as a business partner, what can you do to protect your business?

This article will first explain the basic differences between separate and marital property and then provide you with a number of effective tools that could help protect your business against the possibility of a divorce. We will also discuss several ways to mitigate the damage if you are already heading for divorce.

Before we begin, please keep in mind the following critical piece of advice:

In order to be effective, these protective methods must be in place well before the thought of divorce enters anyone's mind. Obviously, something like a prenuptial agreement needs to be signed before the wedding (and please not the night before), but techniques such as transfers to an irrevocable trust need to be done years in advance. Depending on your state's fraudulent transfer laws, transactions can be voided up to seven years after the transfer. If you and/or your spouse are even slightly thinking about divorce, it's probably too late to take any protective measures.

OK, so let's begin with the basic differences between separate and marital property.

How to Protect Your Business in a Divorce: Separate vs. Marital Property 

Although there are differences from state to state, in general, separate property includes:

• Property that was owned prior to the marriage
• An inheritance received by one spouse solely
• A gift received by one spouse solely from a third party (not from the other spouse)
• The pain and suffering portion of a personal injury judgment

Warning: Separate property can lose its that status if it is mixed or commingled with marital property or vice versa. For example, if you re-title your separately owned condo by adding your spouse as a co-owner or if you deposit the inheritance from your parents into a joint bank account with your spouse, then that property will most likely now be considered marital property.

All other property that is acquired during the marriage is considered marital property regardless of which spouse owns the property or how it is titled.

Marital property consists of all income and assets acquired by either spouse during the marriage including, but not limited to: Pension plans; 401(k)s, IRAs and other retirement plans; deferred compensation; stock options; restricted stocks and other equity; bonuses; commissions; country club memberships; annuities; life insurance (especially those with cash values); brokerage accounts – mutual funds, stocks, bonds, etc; bank accounts – checking, savings, CDs, etc; closely-held businesses; professional practices and licenses; real estate; limited partnerships; cars, boats, etc; art, antiques; tax refunds.

In many jurisdictions, if your separately owned property increases in value during the marriage, that increase is also considered marital property.

It is also very important for you to know if you reside in a Community Property State or an Equitable Division State. There are nine Community Property States: Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington and Wisconsin. These states consider both spouses as equal owners of all marital property (a 50-50 split is the rule). The remaining 41 states are Equitable-Distribution States, which consider factors such as the length of marriage and the spouse's earning power and involvement in building the business when determining a settlement. Settlements in Equitable Distribution States do not need to be equal, but they should be fair (equitable).

You should fully understand this very important distinction between separate and marital property so that you do not inadvertently do anything that might cause your separate property to be construed as marital property.

Dig Deeper: Breakup Blues

How to Protect Your Business in a Divorce: Prenuptial and Postnuptial Agreements

So what is a prenuptial agreement? A prenuptial agreement (prenup) is a contract signed by both parties before their wedding that details what their property rights and expectations (including alimony) would be upon divorce. A well-drafted prenup can 'override' both Community Property and Equitable Distribution State laws and the courts will usually respect such agreements, making them a very powerful tool in protecting your business.

Having said that, prenups can be rather tricky, so it is really important that they are well drafted. To strengthen them, each to-be spouse should be represented by their own attorney. In most jurisdictions prenups should contain the following vital elements:

• The agreement must be in writing (No oral prenups)
• It must be executed voluntarily and without coercion (having your fiancé sign a prenup the day before the wedding is a good way to invalidate that prenup)
• There must be full disclosure (no hiding of assets) - this is another way to invalidate a prenup
• The agreement cannot be unconscionable (this is also another way to invalidate a prenup). For example, if you're making millions, don't expect to get away with only giving up the silverware in the divorce, even if that's what's in the prenup.
• It must be  executed by both parties, preferably in front of witnesses (or a notary) 

Some attorneys even recommend having a judge witness the signing to make sure that no party was coerced.