Unfortunately, a marriage involving an entrepreneur often ends in divorce. While it may not be the wish of the entrepreneur to wind up causing problems by starting a business, the lifestyle they must adopt is usually not one that focuses on relationships. Instead, the entrepreneur usually must work long hours away from home. They may have to spend marital funds on the business instead of on things for the family. Instead of being home to help parent their children, the entrepreneur is usually at work trying to make the business a success. It isn’t surprising that the divorce rate is higher for entrepreneurs and it is important to understand that divorce for these business owners can be much more complicated than for those with traditional jobs. Income can be difficult to calculate, which could cause issues concerning child support and alimony. Equitable distribution can be even more complicated for the entrepreneur’s divorce.
Four-Step Process of Equitable Distribution
The legal term for dividing a couple’s assets and debts is called equitable distribution. A four-step process is used to determine how to divide property in North Carolina: Identification, Classification, Valuation and Distribution.
Identification: All assets and debts must be disclosed by both parties for identification.
Classification: Once identified, each asset or debt must be classified as marital or separate property. Marital property is all real and personal property acquired by either spouse during the course of the marriage and before the date of separation, and presently owned, unless considered to be separate property. Separate property is all real and personal property acquired before marriage, or property acquired during the marriage by bequest, devise, descent or gift.
Is the Business Separate or Marital Property?
If a business interest is acquired during the marriage, using marital funds, it will generally be found to be a marital asset and divided equally between the spouses. If a business interest was acquired before the marriage or with separate funds, it is usually found to be separate property. However, it can be much more complicated than just considering when the business began and with what funds. No matter when the business started, any marital funds and/or efforts contributed to the business to increase the value of the business will be considered marital property. For example, if a husband started a company prior to marrying his wife, he would be entering the marriage with the business as separate property. However, if during the marriage he invested $20,000 worth of marital funds into the company and the effort he put into the company increased revenue substantially, the wife would be entitled to half of the $20,000 as well as half of any increased value due to his efforts. North Carolina uses the “source of funds” rule when evaluating classification and in the case of a business, the court will trace the funds used to start the business as well as financial contributions during the marriage to the business.
Valuation: Once identified and classified, the property must be given a value according to fair market value as of the date of separation.
How Do You Determine Value?
It can be extremely difficult to come up with a true value of a business interest and can be one of the most complicated parts of an entrepreneur’s divorce. Often the non-entrepreneur spouse will value the business much higher than the entrepreneur will. Sometimes if the business interest is small and not overly complex, attorneys can assess the value. Usually, it is best to have an expert (a Certified Business Appraiser or an Accredited Senior Appraiser or a Certified Public Accountant) assist in valuing the business interest. There are three different approaches used to determine the value of a business interest:
- The asset approach;
- The market approach; and
- The income approach.
The asset approach formula is assets minus liabilities equals value. Assets can be tangible, such as the business infrastructure, inventory, and anything else related to the business you can physically touch. Intangible assets are things like patents, accounts receivables, and other assets you cannot physically touch. While some items are easily valued, it can be difficult to value others, such as when trying to value inventory. Inventory is generally valued at cost, but this can vary greatly based on age and type of inventory. And sometimes it is hard or impossible to find a value book that covers the type of inventory owned. The asset approach also does not account for any unrecorded assets or liabilities, which could lead to problems. This approach is best for small businesses.
The market approach is similar to how an appraiser uses comparable homes in a neighborhood to find the value of the home they are appraising. This approach compares similar businesses that have been sold to the business they are valuing. This can be difficult because sometimes there are no similar businesses that have recently sold to compare to.
The most commonly used approach is the income approach. The income approach uses historical data in particular formulas to predict cash flow and profits to calculate the value of a business by evaluating future benefits and the rate of risk or return.
Distribution: The final step is to distribute the property. Usually, marital property is divided 50/50 between the spouses. However, there are times when the court will award an unequal division of property due to many different factors. When the court is considering distribution for divorce involving an entrepreneur, it can be more complicated than for those with a traditional job. The business can be deemed a marital asset, in whole or in part, and must be given a value as such.
How is Distribution Completed?
The most common way for a business interest to be distributed between the spouses is via the entrepreneur buying out the non-entrepreneur spouse. This is only possible if the entrepreneur has enough funds to do so. If a lump sum payment isn’t possible, the non-entrepreneur spouse may be agreeable to a buyout over time. When this doesn’t work either, a business owner can offset the amount owed to the spouse by trading another asset for something of the same value. For example, if the entrepreneur owes the spouse $150,000 but does not have the cash to pay for a buyout, he can instead allow the spouse to be awarded more personal property, an investment account, a vacation home or the like. If this option doesn’t work, the entrepreneur may allow for the spouse to be co-owner of the business. This option is a little tricky, considering you have to have a good relationship to run a business with someone and requires a lot of trust. If all else fails, the least popular option available would be to sell the business and divide the proceeds.
Remember, once you have an agreement or court order in place for equitable distribution, with very little exception, there is no modification allowed. This can be a good thing for an entrepreneur if years after the equitable distribution, the business becomes lucrative; there is nothing that can be done to change the property settlement.