When Couples Own a Company, Divorce Can Bring Confusion about Assets, Equity
One of the most complex divorce scenarios is that of divorcing business owners. From equal partners to couples with shared interest, a divorce involving a business presents a unique set of questions and challenges for all parties involved.
Wisconsin attorney Gregg Herman of Loeb & Herman, has seen his share of divorces involving a business. According to Herman, there are a wide variety of issues to address depending upon each couple’s situation.
In some instances, Herman — who also serves as chair of family law for the American Bar Association — said a couple can actually divorce and remain business partners. There are cases where people do not get along as husband and wife but can get along as co-owners in a business,” Herman said. In those rare instances, it is important that the parties have employment agreements and shareholders agreements, because if their relationship deteriorates they will have to go through a second divorce.”
Divorcing co-owners who continue to cooperate on the business end of the spectrum are few and far between; instead, Herman said it is more common for one of the parties to buy the other party out. To be able to buy out one of the proprietors is not terribly difficult,” he said.
However, when a buyout occurs, the question of how the other person is going to make money comes into play. “They still have to deal with the support component,” Herman said.
The question of how the buyout will play out is also of concern. In general, some common buyout options include payments over time or a lump buyout. In some cases, the couple may agree to sell the company at the time of the divorce, or in the future and share the revenue from the sale. All of those mechanism contain some traps,” Herman said.
UNEQUAL INTERESTS
While it is ideal for a couple to split a business down the center, that is rarely the case. According to New Jersey-based family law attorney Mark S. Guralnick, divorcing business owners usually share interest with other partners or family members.
For example, Guralnick said if an individual and his three brothers co-own a business and the individual gets a divorce, his wife can establish an interest in the business. However, the wife can only have a shared interest in the husband’s portion (one-fourth) of the business. As you can well imagine at the moment of divorce the wife is scrounging to get a clear understanding of the wealth of the business,” Guralnick said. “The husband, who has three brothers — three co-conspirators — has the ability to hide information.”
Guralnick said he has seen this type of case play out, where the divorcing husband prepped the company and his family/business partners for the upcoming split. Through the help of his family, the man was able to hide the true worth of the company. In the end, the wife hired a savvy lawyer who uncovered the conspiracy. The moral of story is they have the unique ability to conspire,” Guralnick said.
In certain circumstances, such as this one, both Guralnick and Gerald Barney, president of California-based AmericanValue Metrics, said a case might require a forensic accountant. If the spouse has been cheating on taxes and the books are cooked, the appraiser may not be able to tell,” Barney said. “Somewhat of a new breed, a forensic accountant is trained to sniff out inconsistencies and uncover hidden money in the world of accounting,” Guralnick said.
For example, Guralnick recalled a divorce case in which the husband moved money around to hide it from his wife. This woman married a man who had a prenuptial agreement. The prenup said he had $35 million. They had two children along the way. Fourteen years later she filed a divorce because he was cheating on her left and right,” Guralnick said. Suddenly he had no money. We went to all this trouble and we discovered his business had no value. He had very strategically protected himself by moving his business assets around.”
PREPARING FOR THE SPLIT
In divorces involving business partners, Herman recommends employing a sound lawyer and tax accountant. If the business will conceivably be a main issue in the divorce, find an attorney who has experienced similar cases first hand. Generally the business is the goose that lays the golden egg and you don’t want the divorce to destroy the business,” he said. You want your lawyer consulting with your tax accountant in terms of how to structure the buyout and to make sure you have no unanticipated tax consequences.”
Similar to a house appraiser, there are specialist trained specifically to appraise businesses. There are several reasons a person might need to have a business appraised, divorce is one of them. “There are business appraisers — their job is to value businesses,” Herman said. Most are CPAs. “Their job is to exam businesses and derive an opinion. They are not nearly as accurate as real estate appraisers. I know of cases where they have been significantly off but most good accountants tend to give a range. They certainly are not perfect.”
Barney said finding a trustworthy business appraiser doesn’t have to be difficult. Barney, who is a Certified Machinery and Equipment Appraiser and a Certified Valuemetrics Business Appraiser, has appraised more than 1,500 small businesses during his career. Barney said when seeking an appraisal, it is important to use individuals who operate under the Uniform Standards of Professional Appraisal Practice (USPAP). “Anyone contemplating a settlement should require USPAP standards,” Barney said.
When done correctly and ethically, Barney said business appraisals are sound conclusions. The appraised value is the most probable value the appraisal can come up for what is called a fair market value,” he said. A business appraisal is a defensible opinion of value.”
“In general, appraisals come in the form of a range. The ranges we use are pretty standard,” Barney said. A range is formulated using the fair market value. The bottom end is minus 10 percent of the value and the top end is 15 percent of the value. Therefore, a business with the fair market value of $100,000 has a range of $90,000 to $115,000. What that doesn’t factor in is the motivation of the buyer,” Barney points out.
CONFUSION ABOUT ASSETS
Barney also said there tends to be a lot of confusion around the terms assets and equity. In short assets include property that has positive financial value. Equity is the assets minus the claims held against the assets. In certain cases, the appraiser must consider the value of a company’s equity. That requires an equity appraisal. That is not always easy,” he said. This generally occurs with smaller business and sole proprietorships that don’t maintain balance sheets.
For example, an individual who works as a contractor may not separate business and personal finances. “The company doesn’t own anything per se that he doesn’t own,” Barney said. It is very hard to determine what the equity is.”
Guralnick recalls a case involving a deputy attorney general and a high-profile patent lawyer. The wife was a patent lawyer who had, over the course of their marriage, garnered some great clients,” he said. While the wife garnered approximately $500,000 in annual salary, her husband “- the deputy attorney general “- matched her income by one one-fifth. The husband claimed interest in the patent business,” Guralnick said. The wife said the practice was worth $100,000. We said it was worth half a million and the judge ruled it was somewhere in between.”
While a client may be inclined to go with the first business appraiser his or her attorney recommends, Barney suggests otherwise. My advice to people who are in this situation, do a little shopping for an appraiser,” he said.Overall, Barney said an appraisal for a small business should run between $2,000 and $4,000. However, he has seen people charged as high as $10,000 to $15,000. Get quotes, there are a lot of appraisers on the Internet,” he said. The appraiser doesn’t have to see the business to appraise it.”
Barney said the turnaround time on an appraisal can vary. His firm has a streamlined system that offers appraisals in about a week. Other appraisers, however, can take up to two months to complete a report.While many are unfamiliar with the concept, both Barney and Guralnick point out that a business has what is known as goodwill value. “Any business has, in addition to its physical assets, a very valuable asset known as good will,” Guralnick said. “You can argue there is some intangible, even an intellectual value.”
For example, in a May 1989 ruling, New Jersey lawyer Charles Abut successfully argued that an entertainer’s celebrity status might generate future business. Abut represented the former wife of comedian Joe Piscopo. The ruling granted Nancy Hayes 48 percent of Piscopo’s goodwill in addition to 48 percent of Piscopo Productions’ stocks.According to Guralnick, the same concept can apply to business owners. It’s a great argument point for lawyers,” he said. Barney agrees with Guralnick. It’s a very common phenomena in very small companies,” Barney said. The value of the business is really professional goodwill. This is one of the most bitter pills in divorces.”
Casey Clark Ney holds a B.A. in communication and has more than six years experience in newspaper and magazine writing. Her Web site can be viewed at www.CaseyClarkNey.com. E-mail correspondences can be sent to caseyclarkney@earthlink.net.
