Protecting the Business from Claims by Spouses

You founded the business or you have taken a family business to the next level.  Now your thoughts also turn to the preservation and protection of the business.  Among the threats potentially facing the business are claims by your spouse, or spouses of your children or partners in the business.  With a divorce rate of approximately 50%, the threat to the business is a reality that the business owner should address.

There are two primary scenarios.  First, is death of a business owner, death of his or her business partner, or death of his or her child, or other beneficiary who may inherit the business.  The second scenario is divorce of the business owner, business partner or business owner’s child, or other beneficiary.

The threat in these situations is not merely that the business owner, business partner and child may lose value to a spouse with claims to the business through death or divorce, but also the healthy continuation of the business itself may be jeopardized by the disruptive and intrusive effect of investigation into the business.  The key to avoiding or minimizing such disruption and loss of value lies in comprehensive and targeted planning well prior to death or divorce.

There are various solutions that can be crafted to meet your objectives.  First, a thoughtful, well-crafted buy-sell agreement is critical.  The agreement can provide that owners of the business may transfer ownership interests only to a specifically defined class, such as children, business partners, or those working in the business, and that all other transfers are void subject to a right of first refusal process.  The buy-sell agreement can further establish valuation guidelines directing use of discounts for lack of marketability, lack of control and other discounts to reduce the value of the business to a realistic value considering the circumstances of the untimely and catastrophic event triggering the valuation and buy-out.

Another solution is for the family business owner to transfer the business or proceeds of the business in trust, either at his or her death or during lifetime, rather than provide for an outright transfer to a child.  For example, a business owner can provide that the business assets or the proceeds of the business will be held in trust for his or her child for life, so that these assets will not be considered part of the child’s estate in the event of death or part of the child’s assets in the event of divorce.

Thirdly, prenuptial and post-nuptial agreements are common in these situations.  Business owners may very well request their children to sign prenuptial or post-nuptial agreements in order to ensure that the family business is protected.

Another solution often overlooked in the context of a new marriage and potential future divorce is for the business owner to obtain a baseline appraisal of the business from a reputable appraiser. If there are issues later about whether or not the appreciation in the business is a marital asset, a baseline appraisal can establish the value immediately prior to the marriage.

Focused planning is the key.  Simply put, planning is the development of creative solutions tailored to the business owner’s financial circumstances, family situation and objectives.