A divorce can destroy your company if you're unprepared. Here are tips on how to protect your business, including how to write a prenuptial, postnuptial, and buy-sell agreement.
Planning for a divorce while you're still happily married may seem both pointless and emotionally draining. But ignoring the possibility of a breakup can wreak havoc on your business
Let me tell you about a recent phone call I had from an Inc. reader who for obvious reasons will remain anonymous.
He founded his company, an automobile-service business, during the mid-1980s. It experienced tremendous growth at the same time that his marriage, unfortunately, was deteriorating. Also unfortunately, he had failed to predict either how successful his company would become or how ugly his marital breakup would get. He hadn't taken even the most basic precautions to ensure the business's survival in the event of a divorce.
When the marriage went down, so did the company, for all the predictable reasons. The couple lived in a state with community-property laws, which meant that--in the absence of any type of divorce planning--all their assets were divided 50-50. Not surprisingly, most of their assets were in the company. To come up with the cash to pay the divorce settlement, our reader had to sell his business.
But the story doesn't end there. With offers from two potential buyers to choose between, he was forced to accept the lower bid because it was for cash on the spot. The judge agreed with his ex-wife and her attorney, who argued that it wasn't fair for her to have to accept whatever financial risk might be attached to the higher bid, which had provisions for an extended payout.
Unpleasant and emotionally charged as it may be to contemplate, divorce planning should be an integral part of overall business and personal financial planning for business owners. And it's not only the breakup of your own marriage you need to worry about. If the survival of your company is a priority, as it is for most business owners, you need to safeguard it against any number of divorces, including those of partners, investors, and, most threatening of all to your company's stability, your adult children.
The first thing to consider is where you live. That's because if you do nothing, state laws will determine the allocation of property in a divorce settlement. Nine states are community-property states (Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin), in which essentially all assets and liabilities acquired during a marriage are split 50-50. Those include business ventures. In equitable-distribution states (the other 41, plus the District of Columbia), the courts divide assets and liabilities accumulated during the course of a marriage according to specific family circumstances and state guidelines, with the split generally falling somewhere between 50-50 and 75-25. (An entrepreneur might be able to keep a settlement down to 25% of a company's value, depending on the judge, the lawyers, and the expert witnesses.)
Most owners of privately held companies would be hard put to come up with cash equal to a quarter or a half of their business's value without, at best, wreaking havoc on their company's operations or, at worst, having to sell part or all of their business. That's why it's smart to put agreements in place that will both be fair to your spouse, should your marriage break up, and ensure your company's survival. Your lawyer's bill for the simplest document will be in the range of $500 to $1,000. The more elaborate and detailed the agreement, the higher the fees. Because your financial situation is likely to change as the years go by, you'll want to include a requirement that you and your spouse renegotiate and update your agreement at specified intervals. The particular strategies you should think about implementing depend on your own special circumstances. Here are some typical situations:
I'm the sole owner of my business and still unmarried, but I'm close to setting my wedding date. I've read that to protect my company I should have a prenuptial agreement. Frankly, that's the last thing I can imagine bringing up at this stage of our relationship.
You're right. Prenups are not easy to talk about. Even if your mate-to-be is willing, you have to maneuver your way between two equally unappealing options: focusing so much on your company's best interests that you wind up alienating your future mate entirely, or worrying so much about his or her feelings that you turn the prenuptial agreement into a virtually worthless exercise.
But however uncomfortable the subject may be, don't delude yourself into believing that you need to be another Donald Trump in order for a prenup to make sense. The key point is to include a plan in which the spouse who is not active in the business will receive a financial settlement rather than stock in the company in the event of a divorce. Whatever the size of your business, and whether or not you're profitable yet, it would be beneficial to have an agreement that also details how the value of your corporate assets will be divided should you part ways.
Even better would be an agreement that covers the other key elements that could be sticking points. It should include an agreed-upon method to determine your company's value in the event of a divorce. (To ensure getting unbiased results, some people specify that two or three independent appraisers be hired, with the couple agreeing to rely on their average estimate. Expect to pay $5,000 to $10,000 per valuation, though valuations can run as high as $25,000 to $30,000.) When companies are valuable--and it does make sense to assume yours will be someday--you should also be sure to include an extended payout, perhaps lasting as long as 5 or 10 years, in order to shelter corporate cash flow from the shock of a one-shot divorce payment.
