How will a buy-sell agreement impact the valuation of your small business in a Texas divorce?
Being a small business owner is tough. I work for a small business and see how difficult it can be to earn the trust of your community, retain clients, serve the clients you have earned, all the while employing people who help you help others. I give Mr. Fagan and our staff a great deal of credit in balancing the job of helping clients and managing a (thankfully) growing business.
This is all going on without the difficulties of a divorce hanging over our heads. If you are simultaneously going through a divorce and managing a business, you have a lot of responsibilities on your shoulders. Couple that with the added problems that can be associated with running that small business with your spouse and you have a potentially combustible situation on your hands.
Now let’s add another layer of potential strife onto this scenario: your business is going to need to be valued for the purposes of being divided up in the divorce. Your baby, the thing that you and your spouse started five, ten or twenty years ago is now subject to division in a divorce case that you may not even want. Insult meet injury.
While we can’t make the situation go away, the attorneys with the Law Office of Bryan Fagan can share information with you that can help you come out of your divorce financially and emotionally intact. There are many circumstances related to your divorce that you will not be able to control. But I’ve found that if you control the controllable factors associated with your divorce, those uncontrollable factors seem to be a lot more manageable.
Buy-sell agreements, business valuations, and divorce
In the event that you own your business with a partner or partners, it may be that you all have signed buy-sell agreements. These are promises that if one of you were to pass away, your interest in the business would pass on in equal shares to the other owners. The alternative would be to have those shares pass on to your spouse via your will or via inheritance. Rather than have an uninterested spouse involved in the marriage, your spouse would be paid their share of the equity in that business and the ownership shares would pass on to the other partners.
Buy-sell agreements can have an impact on the valuation of your business in the event of a divorce. Texas courts typically look to a two-question test when determining the impact of buy-sell agreements.
The first question that a judge will ask herself is whether or not the business is classified as a corporation. Before we start to get into a deep dive into legal jargon, let’s lay out an example to make this all easier to follow. Suppose that you are a doctor who owns one-fourth of medical practice. As part of your ownership of the business, you signed a contract that allowed you to purchase shares of stock in your practice. An additional clause in that agreement requires that you and your wife sign an additional agreement that states in the event that you all get a divorce that you would have to sell all your stock back to the practice group at the same price it was purchased for.
Now, you and your wife are getting a divorce. Upon further review, neither you nor your spouse signed that additional agreement that would force you to sell your shares of stock back to the other partners in your medical practice. Your divorce goes to trial. What does a judge likely have to say about this scenario?
Prior divorce courts have held that the stock purchase agreement makes the unsigned stock sell-back agreement valid against your wife. Basically, your share of the value of the business would be limited to the shares of stock at the time you purchased them, not their current value. The shares are community property and subject to division, meaning that one half of the value of the stock at the time you purchased the shares would be the divisible value of the business. Fair market value, book value or any other method of valuing those shares would not be relevant due to the enforceability of the two agreements.
What value should a family court place on shares held in a corporation when a buy-back is in place?
That example brings us to the question that your family court judge would have to answer: what value will your family court judge place on the shares you own in a corporation? For starters, the value needs to include the price that you are promised under your shareholder agreement.
After that, a court will consider the value of the property interest that you own. Evidence that would go to show the value of the property interest could be financial benefits that are afforded to you as a result of your stock ownership. Things like health insurance provided to you by the corporation, other benefits like company-funded life insurance and perks like these need to be added to the value of the shares themselves.
Question two: Does your shareholder agreement address the valuation of the shares of stock in the event of divorce?
Let's explore an answer to this question via another hypothetical situation that may mirror your own. Suppose that you are an attorney, and you own law practice with one other lawyer. Your partnership agreement with that lawyer specifies how much your spouse will get in the event that you die or left the firm. It is likely that your divorce court would rule that the only way that you could realize the value of the accrued goodwill would be to continue to work at the law firm.
What this means is that your future work for the law firm after your divorce, and any goodwill that you earned, as a result, is not community property. The reason for this is that the partnership agreement that you signed does not control the value of your partnership interest and that of your partner's, individually. What is being divided is your interest in the partnership as a business, not your death benefits if you passed away while working for the firm. The present value of the ownership shares in the partnership, plus other facts- like goodwill. Goodwill is hard to assign a value to and will be the job of the judge to determine.
An appraiser of your business must determine if you can compete with your former business in the event of a sale
The assumption that is attached to these examples that I just laid out for you is that a divorce court has to assume that if you own all or part of your small business and then sell that business, your personal reputation will go along with you. It would follow that this is the reason why your personal goodwill associated with the business cannot be a part of the community estate. Anyone buying the business will pay less for your law firm if the firm bears your name, you have positive personal goodwill in the community and you no longer work for that business.
The next question that we have to ask ourselves is whether or not a court can assume that if you are selling your interest in a small business, can you then set up another business in the same space? Basically- can you become a competitor to your former business? In the event that you are selling your medical practice, but you can then go and set up another practice right around the corner from your old office you are not going to be in a position to maximize the value of your business. It is unlikely that anyone would pay top dollar for your practice if they are aware of your intentions to open up a competing practice. A non-compete agreement would, logically, increase the value of that business.
Let’s go through an example in order to illustrate this point a bit more clearly. Suppose that you own two businesses in the same field. There are no non-compete agreements in either business at that time that you and your husband filed for divorce. It would make sense for you to want to open up another business in the event that you had to sell your two current businesses.
In the event that there is no non-compete agreement in place between you and the business, it would be assumed that in valuing the business a court would need to take into account the likelihood of a competing business being started immediately. If there is a great deal of goodwill in the business this assumption will reduce the value of the business from the perspective of a buyer in the open market.
Finally, courts in Texas may not order a non-compete agreement as part of a divorce decree. Since a court cannot order a non-compete, it cannot assume that you will not compete if you are forced to sell your business as a part of the divorce.
What are the different methods for valuing a business in a Texas divorce?
Given our relatively limited space in this setting, we will not be able to get into all of the details that may otherwise be relevant to discussing how your business may be valued in the context of a divorce. The main thing to understand is that these are projected and hypothetical numbers. There is no sure-fire way to value a business. Your attorney will likely disagree with your spouse’s attorney on valuation methods. We have already discussed that there are factors, like minority ownership in a business, that will decrease the value in the mind of most any appraiser or accountant. In short, there is no generally agreed upon method for valuing a business.
You and your attorney would be well served to hire an appraiser that is well known in your county and who will not charge an arm and a leg. If your attorney has to cross-examine your spouse's expert witness he or she should speak to your valuation expert first to figure out what other methods of valuation would have been preferable.
One thing that an appraiser will do at the outset of their investigation into your business will be to look at the financial documents and make adjustments. The adjustments that will be made are likely to the value of the building you own (if any) as well as any expenses of your business that are actually personal expenses of you or any of the other owners. These adjustments will more accurately tell a judge the “true” nature of your business, rather than the estimates that you had been providing.
The market approach is the easiest to explain, probably because it is the most straightforward. Essentially, the market approach looks to recent sales of companies that are similar to yours. Additionally, if other shareholders have sold their shares recently that sale will likely be an indicator of the value of yours, as well. However, keep in mind that small businesses are not sold frequently, so this method will likely not be that helpful.
Questions about business valuations and divorce? Contact the Law Office of Bryan Fagan
If you have any questions about the material that we have covered today 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 where your questions can be answered and issues addressed. We have a staff of thirteen family law attorneys who work for us and are equipped to handle any problems that you present. We take a great deal of pride in representing the people in our communities and look forward to being able to speak to you and your family about how we can assist you all, as well. Thank you for sharing some of your time with us today.
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Law Office of Bryan Fagan, PLLC | Spring Divorce Lawyer
The Law Office of Bryan Fagan, PLLC routinely handles matters that affect children and families. If you have questions regarding divorce, it's important to speak with ar Spring, TX Divorce Lawyer right away to protect your rights.
A divorce lawyer in Spring TX is skilled at listening to your goals during this trying process and developing a strategy to meet those goals. Contact Law Office of Bryan Fagan, PLLC by calling (281) 810-9760 or submit your contact information in our online form. The Law Office of Bryan Fagan, PLLC handles Divorce cases in Spring, Texas, Cypress, Spring, Klein, Humble, Kingwood, Tomball, The Woodlands, Houston, the FM 1960 area, or surrounding areas, including Harris County, Montgomery County, Liberty County, Chambers County, Galveston County, Brazoria County, Fort Bend County and Waller County.