Business Owners: How to Prepare for Divorce

We have written a good deal about goodwill in divorce is something we have written a lot about. But what about the being a business owner going through a divorce?

Goodwill is a part of business, but it is not the whole business. Both goodwill and the business itself can be divided as property in a divorce. Texas recognizes enterprise goodwill as marital property, to be divided between both spouses in a divorce. On the other hand, personal goodwill goes to the spouse who owns the business as separate property. If you are divorcing your husband or wife, you might face an ownership dispute with your spouse. This blog discusses some common ways to resolve this issue and move forward with your divorce.

Types Of Businesses

There are many different types of businesses that you or your spouse might own. There are a variety of closely held businesses, including professional practices (law firms, medical practices, CPAs, consulting firms, etc.). There are retail businesses (specialty shops, restaurants, online businesses, etc.). Each business is unique. There are particular laws and situations that you will encounter if you own a grocery store as opposed to a law firm.

Here are some general methods of how to handle your business during a divorce:

Option 1: Buy Out Your Spouse

One option is buying your spouse’s interest in the business. This means that one spouse will keep the business and the other will be bought out of it. This is a good option to consider if one spouse wants to keep the business and has enough money or assets to buy out their spouse.

The spouse hoping to buy the business can also use other assets to offset the other spouse’s interest in the business, such as:

• Home equity
• Property settlement note with the principal amount, definite term, the rate of interest, etc.
• Structured settlement to be paid over a period
• Securities that are held outside of qualified plans
• IRAs
• 401(k) plan assets

Option 2: Sell The Business

If neither spouse wants to own the business, or you cannot decide on who gets to keep it, one option is to sell the business. If you do this, you can split the profits and move on. You can use the money that you get from selling the business to invest in your own, new business, which means that you won’t have to deal with your spouse anymore.

There are downsides to consider:

• The sale process can be a lengthy and difficult
• Finding a buyer could take time, meaning that you will remain tied to your ex-spouse until the business sells
• Giving up the business means starting over: hiring new employees, finding a new lease, and rebuilding your reputation with clients

But, despite these flaws, this might still be a good option for you depending on what you want from the divorce.

Option 3: Continue to be Co-Owners

Another option is keeping the business with your ex. For many couples, this is not an option, or a difficult one. After the divorce, you want distance from your spouse. You want to get on with your life. Co-owning a business means that you will still be involved in your ex’s life.

But, if you and your ex are amicable and want to explore this option, it can be a good one. Just because your personal relationship did not work out does not mean that a business relationship will end in disaster.

Types Of Goodwill

There are a few different types of goodwill that will affect how your business will get divided in a divorce. Two of the main types of goodwill include personal goodwill and enterprise goodwill. Most states recognize both types of goodwill, although a few do not when it comes to dividing goodwill in a divorce.

Most businesses have both types of goodwill. Personal Goodwill refers to the goodwill in a business that a particular person has. It is the kind of goodwill related to the owner, what they bring to the business, their relationship with clients, etc. On the other hand, there is enterprise goodwill. This is goodwill based on the business itself as well as the business’ brand. Enterprise goodwill stays with the business even if it changes owners.

In addition to personal and enterprise goodwill, there is residual goodwill. Goodwill is a very broad term, so residual goodwill refers specifically to types of goodwill that can be divisible in a divorce.

Residual goodwill is used to refer to stable relationships between customer and employee in the business. Now it includes human capital from the business, which is also referred to as enterprise goodwill. This type of goodwill remains with the company even if management changes. This type of goodwill can include social capital or research done by the company. As time goes by, more and more aspects of a business can become tangible assets that may easily get divided in a divorce.

In addition to goodwill, there is also tangible property and intangible property. When dividing a business in divorce, Goodwill refers to the business as a whole or parts of the business. If you are going through a divorce, you need to make sure that you consider both tangible and intangible property laws.

Dividing Goodwill In A Texas Divorce

Not all states follow the same laws when it comes to dividing goodwill in a divorce. Some states believe that both personal and enterprise goodwill are divisible in a divorce. Other states believe that one is divisible in divorce while the other is not.
The state of Texas follows a widely held belief among many states that personal goodwill is separate property and enterprise goodwill is marital property. This means that personal goodwill belongs only to the owner of the business. On the other hand, enterprise goodwill can be divided by both spouses, even if one spouse has no claim or stake in the business.
There are a few cases in Texas that have set precedents regarding the laws of dividing goodwill in a Texas divorce. They include Austin v. Austin, Geesbreght v. Geesbreght, and Nail v. Nail.

A few notable findings in these cases include:

• There is a difference between goodwill that applies to a person (personal goodwill) and goodwill that applies to a company (enterprise goodwill).
• Goodwill of a non-corporate, ongoing, professional practice does not constitute community (marital) property in a divorce.
• Goodwill not attached to a person (the man or woman in the marriage) can constitute community property.

Intangible Assets And Goodwill

Intangibles constitute an expense from an accounting perspective. This means that the value of these intangible assets won’t appear on a balance sheet. Accountants address this problem when it comes to purchased intangibles. But, the issue is not addressed when considering self-created intangibles.

In 2007, FAS 1 defined an intangible asset as, “an asset (not including a financial asset) that lacks physical substance. As used in this Statement, the term intangible asset excludes goodwill” (FASB ASC Topic 350-30-Glossary and ASC Topic 805-20-Glossary). This makes intangible assets separate from goodwill.

Certain intangible assets can be identified in divorce. An asset has to meet one of the following criteria to be considered an identifiable intangible asset:

• The asset must be separable from the entity. This means it can get licensed, transferred, sold, exchanged, or rented separately from the entity.
• The asset must come from a contractual or legal right.

Some people argue that goodwill is different than an asset. This is an argument that might help or hinder you in your divorce. This will depend on your personal situation. 

Establishing Business Value

Valuing a business, also known as appraising the business, is an important step if you are getting a divorce. But, it can also be a complex process. Because of this, you should find an appraiser and a lawyer to help you through the process.

An appraiser can determine the best way to appraise or value your business. There are a few different approaches that you can take. A few popular approaches include:

• The Market Approach. This is the most common approach. But, sometimes the market value is not available to work with. If this is the case, you should use another approach. This approach values your property based on the valuation of a similar business that has recently been sold.
• The Asset Approach. Another option is the asset approach. This values the business based on the business’ liabilities and assets. This includes both tangible and intangible assets).
• The Income Approach. This approach uses expected benefits to valuate the business. This can include cash flow and profits. You can use current and past statistics to establish the value of the business in this approach.

For more information on how to value a business, you can refer to our article on valuing a professional practice.

Establishing Goodwill Value

You also need to value goodwill if you want to value your business for divorce. Goodwill value comes from a formula. This formula is the business’ tangible assets subtracted from the total business value. So, you must determine the business value before you can determine the goodwill value.

If you are going to need business valuation in event of a divorce, it is vital you contact an experienced attorney who understands business valuations and can even refer reputable experts to help you. Contact our team today for more information.