GETTING YOURS WHAT WOMEN NEED TO KNOW WHEN A SPLIT-UP REQUIRES SPLITTING A COMPANY'S ASSETS.
(FORTUNE Magazine) – Thirteen years ago, Kathryn Jeffery of Olivenhain, California, quit college and juggled three jobs at times to raise money to help get her husband's geotechnical consulting business off the ground. She even worked as an employee for several years, keeping the books and designing company materials. Now, three kids and 39 employees later, she's going through a divorce.
Jeffery, 38, and thousands of people like her have either helped spouses start businesses or are co-owners with them. In fact, at least a quarter-million husband-and-wife teams run businesses together in the U.S. If things should come down to a divorce, a reality for 50% of couples in this country, one partner--usually the woman--often doesn't get a fair share. "Women have a greater chance of getting screwed, because in many cases the husband knows more about the financial matters of the business," says Ginita Wall, a CPA and financial planner in San Diego who co-founded the Women's Institute for Financial Education (WIFE) and wrote Smart Ways to Save Money During & After Divorce.
If you're going through a divorce, your job is to protect what's rightly yours by valuing the business, negotiating a buyout agreement, and deciding what to do with any stock--all this while trying not to take a tax hit. Here's some advice.
What's coming to you. If you live in California, Texas, Arizona, or one of the six other states where community-property laws reign, then you don't have much to worry about. You're entitled to 50% of the assets accrued during the marriage. Most of the remaining states are equitable distribution states, which means that variables like length of marriage and the wife's earning power come into play when determining a settlement, says lawyer Michael Ostrow of Ostrow & Taub in Garden City, New York, who is president of the American Academy of Matrimonial Lawyers.
Getting your share of a business that was started before the marriage is more complicated. When deciding the percentage due a wife in these circumstances, New York courts, for example, consider 13 factors, including the wife's personal sacrifices and any joint funds used to expand the business, says Lois Brenner, a divorce lawyer with Kantor Davidoff in New York City. It's helpful to have proof of your contributions, such as loan statements or canceled checks for any money you've put into the business, says Brenner.
Determining value. Valuing the business is crucial because it determines how much the wife receives in a buyout or settlement. A business valuation is actually a multiple of earnings assigned to the company based on the value of intangibles, like name recognition, and the physical assets, like computers and equipment. A service business like Jeffery's husband's, or a law or medical practice, is more likely to receive a lower multiple since earnings depend heavily on the owner's customer base and services. On the other hand, a business that has its own customer base and reliable income, like a well-established retail outfit or manufacturing company, would receive a higher multiple.
Search the books. With so much hinged on the value of the business, make sure your CPA is one who specializes in business valuation, trained to burrow through the books to find any and all sources of income. In contentious divorces, some husbands have found a way to report lower profits or inflated expenses to reduce the value of the company and thus the amount received by the wife, says Ginita Wall, who has ferreted out Swiss bank accounts, hidden property, and shady business practices.
The buyout. To structure a buyout agreement, keep in mind the tax ramifications, structure of the partnership agreement, and future cash needs. Here are three common buyout situations to give you an idea of what's involved.
Situation No. 1: The husband has other partners. If there are multiple partners in the business, they may have a provision in their partnership agreement saying that if one partner leaves, then he must sell his shares to the other partners. This is called a crisscross agreement. A divorce may require a crisscross buyout, in which either the husband, with financial backing from his partners, or the partners themselves buy out the wife.
Pay careful attention to how the shares will be valued: Often in buyouts between partners, the valuation method is predetermined in the partnership agreement, says Ostrow. The valuation could be based on last year's book value or profits. This raises a problem if the wife does not agree with the method used. "If we're using last year's profits and the business recently landed a large contract or new client, those shares are worth a lot more now," says attorney Alexandra Kwoka of Kwoka & Hersch in San Diego. Though a judge will most likely rule that the shares be valued at the time of trial, there is a risk the court will honor the partnership agreement instead, says Ostrow. It's best to reach an out-of-court settlement.
Situation No. 2: The wife has founders' stock. If the company is still privately held, the shares will be valued as part of the business appraisal process and included in the buyout amount. If you have founders' stock in a company that recently went public, unloading shares can be tricky since SEC regulations and state laws dictate when founders' stock can be sold and how much can be sold at one time, says Kwoka. (This prevents massive selling from depressing the stock price and affecting the market.)
The SEC may impose a waiting period of six months to a year, or it may require public or SEC notification before the stock can be sold. Worse yet, the brokerage and investment banking firms that helped the business go public may have their own stipulations on when the founders' stock can be sold.
With such a waiting period, problems with valuation can arise. Let's say your stake in your husband's recently listed company is $500,000, which he will give you by selling a specified number of shares of his founders' stock. If there is a six-month to one-year holding period before those shares can be sold, how will the stocks be valued? Just because X number of shares equals $500,000 today doesn't mean those shares won't decrease in value in six months. Kwoka advises asking the court to not value those shares until the time of sale.
Thankfully, transfers of money or assets in a divorce settlement are not taxable. But when you sell stock you received, you'll get hit with capital gains tax. If you expect to need cash from the sale of the stock in the near future, say, to buy a house, try to work out a provision under which the husband will pay for or share in any capital gains taxes incurred at the time of sale, says Brenner.
Situation No. 3: The wife wants ownership of the business. She can fight for it, much as in a custody battle, if she can prove why she is better suited to run the company. One warning from Kwoka: If there are children involved, consider that buying your husband out of the business or forcing its sale may leave him without the income to make support payments.
Promissory notes. If your spouse can't pay you off in a lump sum, you may have to take one. But play it smart. Keep the note as short as possible. If the terms of the note extend payments beyond two years, you may get a tax hit, because the IRS expects all property issues in a divorce to be settled within that time. Anything longer is considered a long-term transaction and is taxable. According to Wall, if you must make a longer arrangement, it's better to make two promissory notes to lessen the tax blow. One note can pay off as much as possible in two years, and the second can disperse the rest over five years.
Finally, make sure the note is properly collateralized with an asset outside the business, like a house or boat. Then do a title search to make sure that same asset is not being used as collateral for other loans or lines of credit. "If the house is already being used to collateralize a business loan, and the business goes under, then that bank has first dibs on the house and you have nothing backing your note," says Kwoka.