March 1, 2013
Closely-held family businesses come with their own unique problems in a divorce. They can be difficult to value, yet the importance of an accurate valuation is critical to a fair and equitable distribution of assets. In addition the future of the business becomes a discussion point when both husband and wife are involved in the company.
The first problem comes when valuing the business. I’d like to share an actual case with you. John and Jane were getting a divorce. John owned a large business which he said was worth $6 million. The couple’s total net worth was $10 million. John said Jane would get half, or $5 million, plus maintenance in a large enough amount that she could continue her previous life style and would not have to work.
John did not want to have his business appraised for the purposes of dividing property in the divorce. He said, “It would upset my employees and besides, I have several contracts I’m trying to put together and I don’t want anything to scare them off!” Jane was willing to accept his offer.
The wife’s attorney talked until he was blue in the face telling Jane she was probably leaving money on the table but she wouldn’t listen. They had 2 teenage daughters whom they both loved and they were trying to keep things on an amicable level. John said he would make trouble if Jane didn’t accept his offer.
John ultimately agreed to give Jane an extra $500,000 cash up front in addition to $5 million and $10,000 per month maintenance. At the end of the day, he came over to thank his wife’s attorney for helping them settle. The wife’s attorney thought, “We just dinged him for an extra $500,000 and he’s thanking me? Something’s wrong with this picture!”
Sure enough – within the year, John sold his business for $67 million dollars!
And because of the potential problem with the daughters, Jane would not file any grievance against John. This case demonstrates how important it is to have the business appraised.
A second problem is how to divide the business when both husband and wife have worked side by side in the business. As an example Mary and her husband Joe owned a fast food restaurant as well as the building it was in. During their divorce they decided that Joe would keep the business and Mary would keep ownership of the building.
Mary became Joe’s landlord and, you guessed it, she raised the rent, she didn’t make repairs, and she did not make an improvement they had been talking about for years. It became an impossible situation.
The solution? They went back to court. Joe bought Mary out and Mary moved out of state.
When you have cases that involve a family business, it is important to look further than just dollar values. These divisions can affect a person’s life for years to come.
A third problem arises when most of the value of their assets is in the business and there seems to be no way to buy out the other spouse. If the husband owns a business that is worth $4 million and he owes his ex-wife $2 million to equalize the property settlement, how is he going to pay that $2 million? The obvious answer may be to structure a property settlement note – especially if he has high earnings and can afford a monthly note payment to her.
The problem comes in figuring out how to collateralize the note. One answer is to collateralize a property settlement note with a QDRO attached to his retirement plan. Whether it is a 401k or a pension, a QDRO can be put in place that, in the event of non-payment of the note, will activate payments from his retirement plan. The payer has to agree to this measure.
In summary, the issues surrounding the valuation and division of a family business in a divorce are unique and can be complicated. A business valuation expert is required to put an accurate price on the company, while good financial planning ensures that the business is properly accounted for in the divorce.
