How Business Ownership Is Handled in a Divorce

A business typically provides income for the family and is also considered property that may be divided between spouses in a divorce. In other words, both spouses may have ownership rights in a family business, and they will likely fight to get their share when the marriage ends.

Is the Business Part of the Divorce Estate?

Before a business can be divided, a judge first has to decide whether it's marital property (called "community property" in some states) at all.

States handle this in one of two ways:

• Community property states. A minority of states treat most property acquired during the marraige as jointly owned. Some of these states generally require an equal, 50/50 split of community property. Others give judges some discretion to divide community property fairly, which doesn't have to be equal.
• Equitable distribution states. The majority of states divide marital property based on fairness, not a fixed formula. Courts weigh factors like the length of the marriage, each spouse's income and earning capacity, and each spouse's contribution to the marriage and to the business. An equitable division of property is often close to equal, but it isn't guaranteed to be.

Regardless of which system your state uses to divide property, a business you or your spouse started or grew during the marriage is typically at least partly divisible. A business you owned before the marriage, or that you built entirely with separate funds (an inheritance, for example), may be your separate property. However, if marital funds or your spouse's work went into growing it, a judge may find that at least part of its value belongs to the marital estate. Determining whether property is separate or part of the marital estate is often one of the most fought-over issues in a divorce involving a business, and the rules for proving that an asset is separate property vary by state.

Three Ways to Resolve Business Ownership in a Divorce

Business ownership can take many forms, from a professional medical or law practice to a retail business or restaurant. Each business has its own quirks, but there are basically three methods of dealing with a business in a divorce.

1. Co-Ownership

With co-ownership, both spouses continue to own the business after the divorce. If the spouses remain amicable, it may be possible to work together after the breakup. But this approach isn't for the faint of heart. You have to have a high level of trust, good communication, and a solid working relationship to make it work. If there's a lot of rancor, continued co-ownership is a recipe for disaster rather than a real solution.

2. Sell the Business and Divide the Profits

The upside of this option is that both spouses can profit from the sale of the business and use the proceeds to invest in their own business ventures, while cutting financial ties with their ex-spouse. The downside is that it can take time. Not every business sells quickly, and it may be months or longer before a buyer is found.

3. Buy Out the Other Spouse’s Interest

In a buyout, one spouse keeps the business and pays the other spouse for their share. A buyout works best when the buying spouse has enough cash or liquid assets to pay off the selling spouse. Alternatively, the spouses can offset the selling spouse’s share of the business with other marital assets, such as:

• equity in the family home
• retirement accounts (IRAs, 401(k)s, and similar plans), and
• investment accounts.

If the business makes up most of the couple’s net worth, the spouses may need a property settlement note (sometimes called a “structured settlement”) which is essentially an IOU paid over time to the selling spouse. Like a bank note, it should have a reasonable rate of interest, a set term, and a principal amount.

For example, let's say Maria and Steve have two significant assets when they split up: $100,000 equity in their home ($50,000 each) and a business worth $350,000 ($175,000 each share). To keep the business, Steve will need to come up with $175,000 for Maria. He can give Maria his $50,000 equity in the home and provide her with a property settlement note for the remaining $125,000. At a 5% rate of interest, Steve could pay Maria approximately $1,350 per month for 10 years, letting him keep the business intact while giving Maria a steady income stream.

Valuing the Business

Before you can sell to a third party or complete a buyout, you'll need to determine what the business is actually worth.

Valuing ("appraising") a business is a complex task that usually calls for a professional business appraiser. The appraiser identifies the relevant financial information (statements, tax returns, and so on) and applies an appropriate valuation method. There are three generally accepted approaches:

• The market approach estimates the business value by comparing the business to similar businesses that have recently sold.
• The income approach converts the business's expected future economic benefits (profits or cash flow) into a present value, often based on historical earnings.
• The asset approach values the business based on its tangible and intangible assets minus its liabilities.

Part of that value is often goodwill—the business's worth beyond its tangible assets, such as its reputation, customer relationships, and brand recognition. Many states split goodwill into "enterprise" goodwill and "personal" goodwill. Enterprise goodwill is tied to the business itself and is generally divisible. Personal goodwill is tied to the owner's individual skills. Treatment of personal goodwill varies a lot by state.

Choosing an Appraiser

Look for an appraiser who holds a recognized business valuation credential, such as:

• Accredited Senior Appraiser (ASA)
• Certified Valuation Analyst (CVA), or
• Accredited in Business Valuation (ABV).

These credentials require passing a rigorous exam and submitting sample appraisal reports for peer review. Other, less rigorous certifications exist, but they don't carry the same weight.

Fees for a business appraisal commonly range from a few thousand dollars to the tens of thousands, based on the size and complexity of the business and the level of detail requested.

In a contested divorce, each spouse often hires a separate appraiser. In a more amicable divorce, a couple may be able to agree on a single, neutral appraiser, which can save money.

Valuing and dividing a business in a divorce is complex and high-stakes. If you have questions about the process or how to decide the best path forward, talk to a divorce lawyer.