Protecting your business if you (or your kids) get divorced.
Protecting your business if you (or your kids) get divorced.
Everybody knows George Steinbrenner owns a controlling interest in the New York Yankees. Fewer people know that over the years, the Boss granted his son-in-law an important management role--and a financial stake in the business. In March, Steinbrenner's daughter filed for divorce from the guy, raising the prospect that Steinbrenner could find himself someplace no business owner wants to be: in business with a hostile ex.
Don't gloat. Divorce can pose a serious threat to businesses--especially those whose owners lack the foresight to protect themselves, no matter how happy their home life. And as the Yankees have demonstrated, it's not just your own marriage you need to worry about but also those of your partners, your kids, and even your partners' kids. "What you don't want," says Shari Levitan, an attorney and business succession specialist with Holland & Knight in Boston, "is to have a stranger in your business."
Planning is crucial for heading off trouble in this arena because you can't do much once a divorce is under way. The first step, especially if you have a partner or plan on one day selling or giving away part of your business, is to insist on a shareholder agreement that sets the ground rules for stock transfers. Cathy Hunt, a Raleigh, North Carolina, attorney who works with entrepreneurs, says the agreement should give the company or other shareholders the right of first refusal to buy back shares at a prearranged price or valuation formula. That way, you'll be able to purchase the shares before they're transferred to a spouse or in-law in a divorce settlement. The agreement can also go one step further, barring any transfer of shares in connection with a divorce.
Then think about prenuptial agreements. If you're already married, of course, it may be too late. You can try for a postnup, but you'll have little leverage and might antagonize your spouse to no good end. Luckily, your kids don't have to make the same mistake. If you plan to give ownership stakes to your children, make sure they get prenups from their future spouses. The whole subject may give you (and them) the willies, but as Hunt explains, "it's a matter of how you approach it." In other words, don't confront a prospective in-law with a 50-page prenup the night before the wedding.
Instead, a good prenup, the experts say, starts with a discussion, and make sure you have it earlier rather than later. If you have adult children, sit them down and explain how hard you worked to build the business, how much it means to you, and how determined you are that they should benefit. Then explain that if and when they get married, you'll insist on this not just for their protection but also to protect everyone else in the family. You could even make it a condition of giving them an ownership stake in the first place. "We do lots of prenups," says Hunt. "Often, both people getting married have assets. They understand. We really do not run into a problem." The complexity and cost of such agreements varies widely depending on what's involved and where you live, but figure on legal fees ranging from $2,000 to $20,000.
A good prenup should be carefully crafted to encompass not just the fair value of the business today but also any future growth or earnings that may result, no matter how high. The parties need separate attorneys--and make sure the less affluent spouse gets one as highly regarded as yours. That will help prevent subsequent claims of inadequate representation or lack of fully informed consent if the marriage dissolves and the agreement is challenged.
If you're not yet married and you're really paranoid, consider transferring your ownership stake into what's called a self-settled trust in an asset-friendly state such as Delaware, Alaska, or Utah. Your kids can do this with their shares as well, as long as they are still unmarried. Such trusts make the business tough to attach in a divorce or other litigation, regardless of your state of residence, says Evelyn Capassakis, an attorney and principal at PricewaterhouseCoopers in New York. The trust holder will retain effective control, but at the price of some administrative headaches and expenses.
Gaetano Ferro, a New Canaan, Connecticut, attorney who is president of the American Academy of Matrimonial Lawyers, says that if you really want to keep your business safe from estranged sons- and daughters-in-law, "don't give your kids an ownership interest in the business. Let them wait 10 or 15 years." Even if the business itself is protected by a trust, he says, a divorcing spouse could have a legal claim to a portion of its value. If that value is high, your son or daughter might be forced to sell shares to pay the divorce settlement. At the very least, it could embroil you in a costly and intrusive valuation process.
Ferro's advice about not giving your kids the business, of course, may be the opposite of what your accountant is telling you. If you want to avoid hefty estate taxes, the plan usually is to start giving children an ownership interest early because you can give only so much tax-free each year. Levitan acknowledges that there is a conflict between avoiding the taxman and avoiding a draconian divorce settlement. "Good estate planning," she says, "may be diametrically opposed to good asset protection."
In trying to reconcile this contradiction, Levitan emphasizes the distinction between economic benefit and control. You may want to convey the former to your children while keeping the latter for yourself. As discussed in this space previously, ways to do this include setting up trusts for your children or simply establishing two classes of stock, one of which has the real voting power. Those are the shares you keep for yourself. (See "Giving the Kids the Business," January 2007.)
Meanwhile, don't ignore the possibility of your own divorce--however remote it seems. Pull out that prenup to make sure it's still valid: It might be useless if you and your spouse have strayed too far from the original terms. Don't take home a lot of unrecorded cash or pay personal expenses through the business, because if a divorce should arise, you'll face major challenges establishing how much income the company earns. Finally, if divorce looms, take special care not to engage in any sloppy accounting, because your ex's lawyer will pounce on any discrepancy in an effort to paint you as dishonest, says Ferro. And don't shuffle assets among relatives or offshore havens. You will only succeed in making the judge think you're a crook.
Even if you hate the Yankees, you can learn a valuable lesson from them by thinking long and hard before giving your son- or daughter-in-law a job. An in-law can always become an out-law, unfortunately, and you're better off not opening the door to claims about his or her contribution to what you've created. George Steinbrenner should have known better.