Central to dividing a small business into a divorce is determining how your small business is legally classified. A key part of operating a small business is the willingness to take on a certain degree of risk. For today's blog post, we can refer to risk as potential liability for you as an individual and business center. The government allows business owners to classify their businesses in various ways to limit the extent of personal liability they may have for losses in Association with your business.
At the outset of your small business operation, you, your spouse, your attorney, or your financial planner may have helped you designate your business as either a sole proprietorship, a corporation, or some partnership. Determining how your business is classified has a great deal of importance for your divorce. The reason for this is that depending upon how the business is classified extra steps may need to be taken to buy the business properly and or liquidate any assets in the business if it is going to be sold. Let's take some time to discuss each type of business formation.
We need to know what kind of business you are operating to be divided properly in the divorce and valued properly. Your business creation may have taken place many years ago, and you have since forgotten how your business is classified. By the same token, you may have allowed coworkers or a business advisor to make decisions in this regard for you. If you do not clearly understand how your business can be classified under the law or what impact those decisions will have on your divorce, then read on to find out.
If you and your spouse, or any other individual in yourself, own the business in tandem, then you likely have what is called a partnership. This is an interesting discussion for us in the context of divorce because you do not own the business as a separate person from your spouse, nor is it owned by your community a state. In actuality, the partnership owns the business, and therefore your business would not be eligible to become a part of your divorce in any way. This means that it could not be divided up in your divorce, nor can it properly be classified as your separate property or that of your spouse.
As a partner in the partnership entity, you need to be aware that the only time your ownership rights come into play for divorce is profit from the business. Specifically, if you share the profits and income from the business are distributed during the marriage, then these profits or income are properly classified as Community property. This is true even if you are interested in the business are classified as your separate property. Again, income earned during your marriage is presumed to be Community property, absent other types of evidence to the contrary.
In this same way, if you are business is classified as a Corporation or as a limited liability corporation. Your interest in the business is neither separate nor Community property. If you own part of a Corporation, only your ownership portion can be subject to division in the divorce. This can become complicated depending upon how ownership of the Corporation has been created. It would make a lot of sense to work with a person who has experience in dividing up business entities in divorce in addition to your attorney to make sure that this process occurs as smoothly as possible.
Finally, the most straightforward of all these arrangements is a sole proprietorship. If you own a small business mowing lawns, baking bread, practicing law, performing any other service, or supplying any other well. Your business is likely known as a sole proprietorship. Absent filing papers to create any other business formation, your business will be known as a sole proprietorship. This is a pretty straightforward method for ownership of a business and all assets. Still, the business will be Community property so long as the business was created during your marriage.
How could your business be divided up in your Texas divorce?
Now that we understand how your business may be classified in a legal sense, we can shift our discussion towards how the business may be divided In your divorce. As if he didn't have enough challenges in front of you in this divorce, as a business owner, you have specific challenges that you need to be aware of and need to be able to develop strategies to tackle head-on. Determining how your small business will be divided should be foremost among those questions.
The question that I receive with regularity regarding business owners and divorce is to what extent the future spouse has to claim ownership in the business. I see this question come up when the spouse has no experience or knowledge of the business but was married to you. At the same time, the business was created and in circumstances where the spouse plays a central role in the business's day-to-day operations. Whatever circumstance you find yourself in, you need to know how businesses are classified for division in a divorce.
Before we get into questions of how your business may be divided in a divorce, we need to determine whether or not it is Community property. If you are at all familiar with our blog post here on this website, then you may remember that all property in existence at the time of your divorce is presumed to be community-owned. This means that both you and your spouse have a right to ask for that property item to be divided in the divorce somehow.
It isn't as if you own 50% of the sole proprietorship business and your spouse owns the other 50%; rather, both of you own 100% stake in any property classified as the community in nature. Each of your roles in developing, growing, and operating a small business may be considered. Still, in general, the law does not provide superior Community property rights to the person who operated the business rather than the spouse who tended the home well you went and worked the business.
For that reason, you should not assume that just because you operated the small business that your spouse couldn't derive some benefit out of business in the divorce. While it is unlikely that a judge would order you to turn over day-to-day operations to a spouse who is never worked within the business, that does not mean that they are not entitled to a portion of that business is the value at the time of your divorce.
You can think of it in this way, almost like your family home. You and your income may have put down all the money for a down payment, made all the improvements on the House, made every single mortgage payment, and you may have done a lot of physical labor to repair and improve the home. With all that being said, simply because he is married to you are spouse has a Community property ownership interest in the home even though his income went towards any payments on the home, and their sweat never went into any improvements made on the home.
I recommend that you not become complacent in this regard if only haven't put time or money into the operation of the business. Just because your spouse may have spent most of their time at home taking care of your children, Anne maintaining your residence while you worked, does not mean that she is not in a position to extract some monetary benefit out of business at the time of your divorce. In other states, this may be the case where no benefit could be derived unless a person puts some money and time into a business. However, that is not the case in Texas.
Option number one for dividing your small business in a Texas divorce
The first method that could be employed in your divorce case to divide up your small business would be to award you the business and for money to be paid out to your spouse to compensate them for their Community property interest. Of all the various methods that could be employed in a Texas divorce, this is the most frequently utilized by parties and judges alike. As we mentioned a moment ago, if you are the spouse who has more frequently played a role in operating the business, the business will be awarded to you.
Consider if you own a machine shop and you are an experienced machinist. You would likely be awarded complete ownership of the business because that business is in line with your skill set and experience and because your spouse likely has no skills associated with the actual product that your business creates. They may have kept the books or run the office for the machine shop, but those are skills largely transferable to other work areas. Or as, machinist experience does not exactly lend itself to working in corporate finance or practicing medicine.
So long as the business is characterized properly as Community property, they will be paid money out of the divorce for their ownership stake in that business. Two issues come to mind regarding a subject like this. The first is that you need to make sure that your business is properly valued. This means that you and your attorney will need to look into hiring a person in your community who is familiar with appraising and valuing small businesses of your type. You may have a rough idea of what your business may be worth, but I could tell you that this number may differ significantly from what an expert or experienced accountant may believe.
Furthermore, if your case were to go to a trial, you almost certainly would need an expert witness available to testify regarding the value of your business currently. A judge will be looking for objective and unbiased information, and a party to the divorce is not exactly the most unbiased person in the world. Work with your attorney to locate a person who you can trust to value the business. Your spouse will likely be doing the same thing.
The other issue that bears mentioning in this regard is that you need to have sufficient cash on hand to pay your spouse their portion of the ownership interest in your business most people, not surprisingly, do not have hundreds or even 10s of thousands of dollars laying around to pay a spouse their ownership interest in a business in the divorce. Many people will take out a loan to pay their spouse immediately or cede other Community property to their spouse equal to the value of the business. Finally, you may be able to work out an agreement with your spouse whereby you pay them a certain percentage of net profits each year until their ownership stake in the business is paid in full.
Option number two for dividing your small business in a Texas divorce
The next option that you may choose to employ and divide up your small business in the divorce would be to sell your business and then utilize the profits from the sale to pay each spouse. I would see this situation happening when you and your spouse cannot agree on how to divide ownership interest in the business or discuss who should own the business after the divorce. If you and your spouse cannot negotiate well in the subject, a judge may order the business to be sold.
Or, you may find yourself in a position where neither of you wants to own or operate the business after the divorce. In that case, you may be able to mutually agree to have the business divided up and sold as a part of your divorce. It could be that your business isn't generating sufficient income to make it worth your while to operate the business after the divorce. By the same token, if you cannot come up with the money to pay your spouse their portion of the business, selling the business may be your best option.
Keep in mind that selling a business is not as simple as selling a home. Issues with valuing the business, finding a willing buyer, and marketing the business for sale are all complex issues in their own right. As part of the divorce, you and your spouse should agree to a method to sell the business, considering all of the factors that I listed above.
On the flip side, selling the business may be in your best interest in that the profits can be used to help you set up your life post-divorce. Debts, attorney’s fees, spousal maintenance, child support, college for your kids, and even the money needed to build another business can all be taken from the sale proceeds of the business to benefit you as you transition into life after your divorce.
Option number three for dividing your small business in a Texas divorce
A third option that may be utilized in your divorce to divide your business would be to continue operating your business with your spouse. This is not the most desirable setup, in my opinion, and is not utilized all that much by parties in divorce cases. It would be an odd arrangement for you to work side by side with your ex-spouse. This is true both from the standpoint of your relationship with one another and your relationship with your co-workers and employees.
However, if both you and your spouse play central roles in running the business and are essentially indispensable to the business's day-to-day operations, then this may be a setup that works for you all. It takes a special set of circumstances for this all to be true. You should speak to your attorney about this possibility and then talk directly to your spouse to determine if it is an option that is worth pursuing.
Questions about the material contained in today’s blog post? Contact the Law Office of Bryan Fagan
If you have any questions about the material contained in today's blog post, please do not hesitate to contact the Law Office of Bryan Fagan. Our licensed family law attorneys offer free-of-charge consultations six days a week in person, over the phone, and via video. These consultations are a great opportunity for you to learn about Texas family law and how your family may be impacted by filing a divorce or child custody case.