Taking the right steps during divorce proceedings can mitigate risks to entrepreneurs’ most valuable asset
With business closures, quarantines, and household isolation measures continuing throughout Canada and around the world, many couples forced into a common domestic situation for an extended period are finding their relationships tested. Family law experts predict an uptick in divorce proceedings as a result of the coronavirus pandemic — which could have serious implications for married business owners.
“When spouses experience a marital breakdown, they can either go into the court system, or into the collaborative law or mediation system,” explained Nathalie Boutet of Boutet Family Law and Mediation. Boutet is a Family Law Lawyer, Mediator & Family Enterprise Advisor™, specializing in high-net-worth families and business owners.
“The atmosphere of the divorce is more adversarial when it goes through the court system, while people are generally more cooperative in a collaborative negotiation and mediation,” she said.
The price of friction
While many business owners will already have business valuations for market value purposes or as a matter of internal corporate information, valuations obtained for family law purposes tend to involve more scrutiny.
In an adversarial system, the parties involved stand to undergo a more expensive process. The business owner could pay a professional to come up with a valuation of their company, which the other spouse would not trust in most cases. Another business valuator would be brought in to do a critique, leading to additional professional costs and fees.
A valuation can turn on a number of assumptions or assessments. In an adversarial setting, a business valuator representing one party may exercise discretion that would favour the business owner, and their counterpart will try to pinpoint the places where another assumption could just as easily have been made.
“If there’s no middle ground, the matter will go into the court system where a judge would make a decision, and that can get really expensive and protracted,” Boutet said. “And since court proceedings are of public record, corporate financial statements, corporate and personal income tax returns, personal bank statements, and bank account numbers can all be laid bare.”
Divorces that are conducted through a mediation or a collaborative process, on the other hand, are more contained and tend to foster a higher level of trust. The couple brings in a team of professional advisors, who could tap one neutral business valuator. In such a case, the valuator would act impartially, making assumptions or assessments that tend to be fair for both spouses.
Finding a balance
Getting to a fair business valuation, however, is only the first step in arriving at an equitable outcome.
Within an estate, the business tends to be one of the largest-valued assets. Canadian family law provides that for married couples, the parties each get 50% of their net family property that was acquired during the marriage. This means that the non-business owner is likely entitled to a large part of the business value . The payment to the non-business owner may be substantial and may cripple the operations of the business. Even if the law provides that an equalization payment must be payed within 10 years, couples that are working together can usually find ways to satisfy both parties’ interests in a manner that allows the business to continue its operations.
“Where the real strategy comes in is figuring out how to give the non-owner their fair share,” Boutet said. “And within a framework of immediate payment or payment over 10 years, there’s room for people to find a solution, especially if they’re going through a collaborative or mediation process.”
One approach to consider is a give-and-take involving other assets. The non-business owner could be given some ownership stake in the business and a greater stake in other family assets, such as the house. “However, there can be tax implications when one person transfers shares or other assets to the other,” Boutet said.
Another option is for the business owner to offer payments over time. They can do this by giving the other party dividend-paying shares. But even in collaborative law settings, some business owners might prefer a clean break and thus not be comfortable giving the non-owner access to future financial information pertaining to the company.
“Saying that, I also have cases involving very valuable businesses where the owner is quite comfortable to give non-voting shares to the former spouse as part of the settlement.,” Boutet said. “Ideally, I believe everyone should work together to minimize any erosion of value due to taxes and professional costs, while balancing the rights of the non-business owner with the healthy future operation of the business.”