24 July 2014

The Business and Divorce

A spouse’s business (whether whole or part) will constitute part of the marital estate on divorce and, as such, will be considered in any financial settlement.
One of the fundamental principles in assessing financial entitlement on divorce is that the family’s assets should be shared on a basis which reflects the respective contributions of the parties. In doing so the divorce court assesses that the contribution of the ‘homemaker’ is no less significant than that of the ‘breadwinner’ and does not discriminate between the roles played by the husband and wife. This means that a spouse is likely to be entitled to a share of the value of the business even if he or she had no direct involvement in it.

The starting point to such an evaluation of financial entitlement on divorce is equality. It is only in the exception that the divorce court will be willing to allow one spouse a greater share of the available wealth. The proposition of pre-marital wealth is one such exception, for example the family business passed down through generations on one side. That is not to say the full value of the business is ignored but the pre-marital wealth value element is treated differently to the marital acquest – i,e, the wealth generated during the marriage.

When advising the spouse with the business interest, it is therefore very important to independently establish the value of the business at the time of marriage, as well as the value on divorce.

The divorce court will require an independent valuation of any such business interest as part of the financial disclosure process.
There is no one method of valuing business interests although there are preferred industry and sector led valuation methods depending on the nature and constitution of the business.

The valuation is very much a paper exercise as in reality the court will be reluctant to force a sale of the business – and “kill the goose that lays the golden egg” – although in the most extreme circumstance this is within the discretionary powers of the divorce court.

The preferred approach is to preserve the business and compensate the other spouse with a larger share of the other assets and/or maintenance. The value of the business thus needs to be established to ensure the off-setting against other marital assets is done at fair value.

The divorce court retains discretion to do what is considered fair and in doing so can be quite creative. For example, if it is not possible to off-set full value against the remaining marital estate, the divorce court can compensate a spouse via the income derived from the business or divide shares and alter the shareholding (subject to any restrictions).

A valuation is usually secured on a single joint expert basis to minimise cost – i.e. a valuer is agreed and is appointed by both parties to report to the court.

The appointed valuer is very often asked to consider:

  • what property or assets sit on the business balance sheet
  • whether the accounts reflect market value and, if so, what value? Is it a significant value?
  • is there a pension within the business (i.e. a SIPP or a SASS) and, if so, what assets does it own and do the accounts reflect fair market value?
  • can cash be extracted from the business and, if so, how is this achieved in the most tax efficient manner and without undermining the integrity of the business and its ability to trade?
  • is it possible to secure borrowing against the business or its assets and, if so, on what terms?
  • how is the ownership of the business distributed (i.e. majority/ minority shareholding; partnership – equal or otherwise) and in the event of a family owned business, would they act together and potentially undermine any reallocation of interest on divorce?
  • what income can be drawn from the business via salary, dividend, directors loan and any other means?

Some businesses are, in reality, income streams – usually in the case of the sole trader where the business and the individual are one and the same. This type of business usually has no capital payment. In such cases there is no need to go to the time, trouble and expense of formally valuing the business as the other spouse’s claim can be met by way of a maintenance order.

Although the courts can order the sale of business, they are reluctant to do so. That said it must be possible to compensate the other spouse from the business (via liquidity) or other marital wealth to avoid the prospect of sale.

There are legitimate and creative means by which the business can be structured to mitigate the impact of divorce. It is recommended such steps are taken prior to or at the outset of marriage so any restructuring or protective measure can be said to be truly independent and at arm’s length. Such steps taken during the marital schism may be set aside as an attempt to defeat a spouse’s legitimate financial claims on relationship breakdown.

Legal and Accountancy advice should be sought to put in place protective measures, to include:

  • a pre-nuptial agreement, whereby a spouse forgoes (by consent) any future claims against the business
  • discretionary trusts: ownership of the business does not vest in the spouse but is held in trust for a class of beneficiaries, of which the spouse can be one
  • a shareholder’s agreement that prohibits the transfer of shares to a spouse or former spouse, allowing the business pre-emptive rights

We recommend that you think carefully about involving your spouse in the business. The more involved the spouse, the more likely he or she will secure a vested interest.

It is also important that you pay yourself a competitive salary, rather than reinvesting everything back into the business. Your salary is income and, as such, can be enjoyed now. If you re-invest your profit back into the business then you are arguably “fattening the turkey” and your soon to be ex-spouse might claim that he or she is entitled to more money or a larger percentage of your business because he or she did not derive any benefit and all your money went back into the business instead of the household.

These are merely illustrative examples but we know that managing a business in these challenging economic times is hard enough without the additional worry of a divorce and its impact on the business. Time is of the essence in divorce and expert legal advice in the early stages is a worthwhile exercise.

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About the Author
Kevin Harris-James, Partner, Head of Birmingham Office
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