What happens when divorce splits a business? — Six possible scenarios
Many businesses are founded and run by a husband and wife team. What happens to the business if they divorce?
The ‘clean break’ principle
The Family Court’s position is that whenever possible, there should be a clean break between ex-spouses. This means a property settlement, with the combined asset pool being broken into two chunks. When the assets include a business, the property split can take place in a number of ways.
Value of the business is offset by other assets
The best scenario is when there are additional assets to be divided. For example, if the business is valued at $500,000, there is other property in the asset pool with roughly the same value and the court determines that the appropriate division is 50/50, it’s easy to do a straight swap or split.
Property settlement from company profits over time
Obviously, for this to work, the company has to be profitable. Secondly, there needs to be an element of trust between ex-spouses, because if only one of them is working in the business, the other can’t necessarily gauge whether the profit on the books is correct.
Lawyers can provide for certain disclosures, such as the books being checked by an independent accountant. You also need fair and adequate default provisions, so that if the agreed instalments are not paid, then and only then is the business sold.
Borrowing money so one spouse can buy out the other
This is possible if the company’s assets are sufficiently valuable for a financial institution to accept them as security.
Selling the business on the open market
Clearly, if the company makes a good profit, owns valuable intellectual property or has substantial assets (buildings or land), it has a better chance of a successful sale than if it doesn’t. Ideally, the business should be at arm’s length to the proprietor, have good governance, employ qualified managers and have a clear structure of responsibilities.
An SME running a system of production or manufacture is more likely to be attractive to buyers than a professional services company where the goodwill is attached to the proprietor.
Bringing in another investor
If the company’s profits are to be paid to the proprietor’s former spouse instead of being reinvested in the business and there is a risk that the company will be sold in the case of default, it’s unlikely that you will be able to attract an arm’s length investor. However, an interested relative like a parent or new spouse may be prepared to help out.
Both people continue to operate the business
This can happen when it is in the interests of both people or there is no practical alternative, because the business is their only asset and it cannot readily be carved up.
In some instances, couples have used consent orders in the Family Court almost as a constitution of the company, setting out how they will delegate tasks and manage affairs into the future. I’ve seen other instances where employment contracts for the husband and wife have been incorporated as an annexure to court orders. This is very rare and usually only temporary, until there are sufficient funds for one spouse to buy out the other.
Know when it’s time to move on
Ultimately, successful businesses are built on successful relationships. Couples who have separated or divorced are not likely to be ideal long-term business partners, no matter how civil their break-up was. And if you can no longer stand the sight or sound of the person who used to be your life’s partner, it’s best to pack up your kit bag and move on. Just make sure that you look over the edge and plan your landing before you jump.
For further information please contact: