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3 Strategies Entrepreneurs Can Use to Preserve their Business After a Divorce

On today’s episode of Money Talks, host Tiffany Kent, CFP and Founding Partner of Wealth Engagement, LLC, discusses how divorce can affect your small business’s financial standing.

Transcription: 

Tiffany Kent:
Odds are that your small business is one of the most important and most valuable asset, you’ve invested countless hours and resources into your business, but if you’re married, unfortunately, between 40 to 50% of marriages in the United States end in divorce. A divorce can have a huge impact on a business if it’s included in a settlement and the process can make it difficult for owners to focus on running their business because they’re distracted by meetings and negotiations.

Tiffany Kent:
But first, when you get divorced, you have questions about how to determine what the business is actually worth, the best way to divide a business in a divorce, and just how to get the best outcome in a divorce with a business involved.

Tiffany Kent:
There are a few things you need to understand about the challenges of divorce and owning a business. There’s more than one valuation method and the various methods can produce wildly different results. The best method to divide a business in a divorce isn’t the same for everyone. Determining what percentage of a private business is considered marital property can also be difficult.

Tiffany Kent:
Divorce with a business involved has less to do with laws and more to do with money and negotiation, but let’s first touch upon business valuation. It’s a common misconception when getting a divorce valuation for divorce purposes, that business evaluators will produce a report with a single value for your business.

Tiffany Kent:
At a high level, there are three methods to value a business. The first one is asset value approach, which is based on the fair market value of the business’s net assets. The second one is the comparable company approach, which values a business based on what other similar businesses have sold for in recent past. Lastly, the discounted cash flow method approach uses projected cash flow earnings to derive a present value for the business. Depending on the type of business you have, one approach may be more suitable than another.

Tiffany Kent:
Add to the mix that each of these three valuations can produce wildly different results. How do you reconcile that? Let’s say you’re the one of the 28% of Americans who is a small business owner and you want to sell your business ownership. And in this example, you’re not getting a divorce. Naturally, you want to use a valuation method that results in obtaining the highest sales price for your business. And your spouse would want to use that valuation method too. But since you’re getting a divorce and your business will become a marital asset subject to community property divisions such as in the state of Washington or California, or an equitable distribution, which is in the state of Georgia, New York, or New Jersey, you might want to use a evaluation method that results in the lowest business value. You and your spouse now are immediately at odds, which in the blink of an eye can turn your asset into a liability.

Tiffany Kent:
The next part of the equation is: do you own a business or are you the business? Let’s say you’re a financial advisor like me and run a small investment advisory firm. My business is a success because of the relationships I have built with clients over time, as well as the licenses I have, like the Certified Financial Planning credential and the Series 65, which allow me to run my business.

Tiffany Kent:
Now I need a business valuation for divorce, but the value of my business is based on my efforts and relationships. So what happens if I take all my clients with me, or I’m the only person that brings in business income, or I’m the only one licensed to perform the service? What value does the business really have? Good question. Without me, there may not be any business and, in turn, no value. This is what I call key man, or in my case, key woman problem.

Tiffany Kent:
Next question. Did you reinvest in the business in lieu of taking a salary? It’s not uncommon for the self-employed to invest everything they have into growing their business, and that might even include not taking a salary. Maybe you thought, “My spouse has a good job so I’ll rely on him or her to pay the bills and cover us financially and I’ll forgo a salary and instead reinvest any profits into my business,” so that’s what you did. And as a result, your business grew more quickly than it would have had had you taken a salary.

Tiffany Kent:
Now, there are a few problems. First had you drawn a salary, there would’ve been less money available to reinvest into your business, and as a result, the growth rate of your business would have been slower, leading to a lower valuation at the time of your divorce. Second, at the time of your divorce, because your business value would likely be inflated, you may have had to offer your soon-to-be ex-spouse more of your marital property or assets to come to the agreement you both found fair. Third, because you’ll no longer have your spouse to support you after your divorce, you’ll have to take a salary, which leaves less cash available to reinvest into your growing business.

Tiffany Kent:
Over time, due to the slower growth rate of your business and the fact that you had to give up more than you should have, assets to keep your inflated and valued business, it may have delayed your retirement and forced you to remain working for longer than you had originally planned.

Tiffany Kent:
Now we’re starting to see why business valuation and divorce can be a very complicated issue to resolve for a divorcing couple. The best method to divide a business in divorce case isn’t the same for everyone. Just as there are various methods to value a business, there are also numerous options for how to divide a business in a divorce. And the option you choose is entirely dependent on your unique situation.

Tiffany Kent:
Here are a few examples. You could sell the business. On the surface, this might be one of the easiest ways to go. Whatever proceeds you receive from the sale, you and your spouse could divide as you see fit. You could continue to co-own the business. Another way to divide the business may be to not divide it at all. If you and your spouse are getting a divorce when you own a business together, you can each play an active role in operating it and you may wish to leave things as is. On the surface, this may seem like a good idea, as it eliminates the need for evaluation at the time of your divorce and removes this asset from your divorce negotiations. It also allows each of you to enjoy the perks of a family business, maintain your current salaries, and share in the net profits of the business. But you’re getting a divorce, communication challenges are a major contributor to the reason for ending a marriage. So divorce and owning a business together could be difficult or impossible.

Tiffany Kent:
The last strategy, you could buy out your spouse’s business interest. Buying your spouse out of the business may seem simple enough, you would get to keep the business and they would get to keep the other comparable, tangible assets or meritable property. But in order to provide a basis for the negotiation of the buyout amount, evaluation would be required. And it’s entirely possible that the amount could be higher than what you could actually sell the business for in the open market.

Tiffany Kent:
As we all know evaluation and the actual sales price can be two entirely different things. Since you are not selling the business on the open market, you really don’t know what the true sales price and the net proceeds would be. But the problem is that your ex may now expect you to buy them out of the business using the valuation amount.

Tiffany Kent:
So far I’ve discussed many of the issues you and your divorcing spouse will face that are directly related to divorce with a business involved. It’s a tough process and try to trust your advisor’s advice. Like your divorce lawyer and his or her experience, they have been through this process with several others before and they know how to navigate the situation well and without emotions. That’s all for today. We’ll see you next week on Money Talks on the Atlanta Small Business Network.


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