What Happens when a California Business Ends up in Family Court?

Owning and operating a business can take up a lot of your time and energy. And in some cases, this can put a major strain on your personal life. Over the years, we have seen numerous high-profile cases of business owners who end up getting divorced. The largest divorce settlement in U.S. history happened recently when Amazon founder Jeff Bezos agreed to give a 4% stake in the company he founded to his wife Mackenzie. Her share was valued (at the time of the divorce) at $35 billion.

Businesses both large and small frequently end up becoming part of a divorce proceeding, and when this happens, things can get complicated, and they can become very contentious. In a lot of cases, only one of the spouses is heavily involved in the business, and many businesses have outside partners as well. 

How do you divide marital assets in a fair and equitable manner while preserving the viability of a business and at the same time preserving delicate family relationships? This is a question many divorcing spouses have had to grapple with.

California Divorce Laws

California is a “community property” state. This means that assets and debts that were acquired during the marriage are considered to be equally owned by both spouses. There are a few exceptions to this, such as gifts and inheritances one of the spouses receives, but a business that was started after the couple was married is not one of these exceptions.

Even if just one of the spouses went into business after the marriage and the other spouse never had anything to do with it, the business still belongs equally to both spouses. The same rule would still apply if the business has outside partners. For example, if one spouse owns 25% of the business with three outside partners owning equal shares, in theory, the other spouse would be entitled to own 12.5% of the company as part of the divorce settlement.

In practice, things do not usually work out this way. If one of the spouses is not involved in the business, they will most likely want compensation for their interest in it rather than retaining ownership. And this is what often complicates matters.

If a spouse is to be compensated for their interest in a business, it must first be determined what that interest is worth. And since there are multiple ways to value a business, this can become a major point of contention. 

For example, the spouse who is involved in the business may want to use “fair market value” – what an outside party would pay for the business based on comparable business sales.  However, the other spouse may want to factor in “goodwill”, or the reasonable expectation that the business will grow in value in the future based on its established reputation and position in the marketplace.

Once an agreeable price is finally determined, the spouse that retains the business must figure out a way to compensate the other spouse. If the couple has other valuable assets, such as real estate properties, stock investments, etc., the spouse who is selling their share of the business could be compensated by receiving a larger interest in the other outstanding assets.  If there are no such assets available, then another arrangement must be made; such as a lump sum payment or installment payments over time. It may also be necessary to finance this purchase if there is no liquid capital available.

It should be noted that even businesses that were started before a couple was married could still end up in family court. This would happen if the business grew and gained significant value during the marriage.

For example, let’s say you started a dental practice in San Diego a couple years before you were married. At the time of the wedding, the practice was worth $150,000. You were married for 10 years, and during that time, you added some new dentists, opened up another office, and took on a couple of partners. Now, your practice is worth $2 million dollars. In this scenario, the vast majority of the equity you own in your practice would likely be considered community property.

How to Prevent Major Trouble When a Business Ends Up in Family Court

If you own a business in California, it is a good idea to prepare for worst-case scenarios, such as a divorce or death.  While you may not be able to keep your business from being part of a divorce, you can take steps to minimize the damage this may cause:

• Use a Prenuptial Agreement: If you are bringing the business into the marriage, ask your fiancé to sign a prenuptial agreement stating that the business (or your share of it) is not part of community property. If you started the business after you are married and you are still on good terms with your spouse, you may want to consider a postnuptial agreement. Postnuptial agreements are not generally seen as favorably by the courts, but if they are signed well in advance of any separation or divorce, they should still be helpful in providing some guidance on asset division if a divorce proceeding ever arises.
• Create a Buy-Sell Agreement: This is an agreement that is often used between business partners to spell out the specific terms and conditions in which changes of ownership can occur. For example, a buy-sell agreement can limit your spouse’s right to own part of the business, and it could also give the other owners the right to buy your spouse’s interest at a price that is reasonable and predetermined.
• Do Not Comingle Your Finances: It is always best to keep the finances between your business and your personal life separated. As much as possible, do not use funds from your business to purchase personal items or cover personal expenses, and vice versa. The more commingled your finances become, the harder it will be to untangle everything later on.

Need Help with Business or Family Law Matters in Southern California? Call Garmo and Garmo, LLP for Assistance

When business owners get divorced, it can become a messy situation. If you are facing these circumstances, you need attorneys who have an in-depth understanding not only with family law, but business law as well. If you are in San Diego, El Cajon, or anywhere in Southern California, call Garmo and Garmo, LLP at 619-441-2500 or message us online to schedule a confidential consultation with one of our attorneys.