Most people know that the divorce rate is quite high, with the fastest growing demographic for divorce being Baby Boomers. What many people may have not known is that last year, a report was issued by Babson and Baruch Colleges, which identified an exciting trend in the U.S. economy: entrepreneurship in the United States is at a 14- year high. Logic therefore tells us that many entrepreneurs will divorce and will need to face the very difficult issue of the valuation and division of their business as part of a divorce. It may be true that “hell [hath] no fury like a woman scorned,” meaning there is no force as powerful as an angry woman who feels she has been treated unfairly. With that analogy in mind, I invite you to meet the “scorned” entrepreneur who must face the valuation and division of his or her livelihood in a divorce.
After representing many business owners in their divorces, it never gets easier to tell the business owner that the business which provides their livelihood to support the family is an asset of the marriage which must be valued and then made part of the property division. This means that unless the business is going to be sold, the spouse who operates the business will need to buy out the other spouse’s community property interest therein. No joke, delivering this news is akin to delivering bad news about a parent or a child. I have yet to see an entrepreneur who does not go through the five stages of grief in hearing this news – denial, anger, bargaining, depression and acceptance.
An entrepreneur usually does himself or herself no favor by thinking this issue will “go away” (denial). Instead it is best to work hard toward acceptance and face reality. This means working with their lawyer and financial experts to craft the best position possible and then facing the music: how to accomplish the buy-out. These are typical elements of a buy-out strategy and they can be used separately or in combination with one another:
- Make an Offset Against Other Assets. For example, if there are sufficient assets other than the business – a house, for example – then the entrepreneur may keep the business in exchange for the other spouse keeping the house, assuming those values are equal.
- Secure a Promissory Note. It is best to secure the promissory note against collateral outside of the business (e.g., other assets). There are various sources for such security – including a spouse’s interest in a vested pension via a qualified domestic restraining order (QDRO) on his/her half of such a pension plan.
- Arrange for Bank Financing. If the business is a non-professional practice, this may include financing of account receivables.
- Identify Private Equity Financing. In essence this means raising capital from an outside investor.
- Bring in a Partner. The buy-in of a partner is a means of raising capital.
- Borrow Against Life Insurance. The borrowing transaction can be against existing whole life or other cash value insurance policies awarded to the entrepreneurial spouse as part of the property settlement.
- Make a Stock Transfer to Trust. Transfer the stock that is allocable to the spouse being bought out into an irrevocable trust for his/her benefit and appoint an independent trustee. This option is particularly helpful if the business cannot be sold now, but will be sold in the foreseeable future when the trust can get the proceeds and diversify.
- Set Up an Investment Credit Line. If there are eligible assets to invest, put an investment credit line in place and use a portion of these investible assets while keeping the remainder in cash. This reduces the impact to the investment account by maintaining assets to generate income and fund regular business functions. This is particularly important if the investment account is used as the day-to-day operations account for the business.
Buying out the business in a divorce is a bitter pill to swallow, but the quicker that the entrepreneur makes this decision realistically, the more time there will be to make the best decision possible on how to accomplish it.