The laws in community property states like California significantly affect how assets are divided upon divorce. If you are an entrepreneur or business owner, it is crucial to understand the business implications of community property laws whether you are:
- Already married
- Planning to get married
- Married and planning to start a business
- Planning to get married before starting a business
This article will discuss how community property laws affect the division of businesses, particularly if one spouse is the owner of the business and the other is not. We will also discuss legal strategies to preserve control of a business post-divorce and the role of forensic accountants and valuation experts.
Community Property vs. Separate Property
- Community property, also known as marital property, refers to any income, assets, and debts acquired during marriage. It also includes anything you purchased with income earned while married. Community property is generally divided equally upon divorce.
- Separate property generally refers to assets acquired before marriage or received as gifts or inheritances during marriage.
When You Started Your Business Affects Its Division In Divorce
- If you started your business during marriage, it would generally be considered community property in California, even if your spouse was never an owner, employee, or actively involved in the operations.
- If you started your business before marriage, its original value from pre-marital efforts and investments may be considered separate property. However, any appreciation in the value of the business during the marriage may be treated partially or fully as community property.
Sole Legal Ownership Does Not Guarantee A Business As Separate Property
If you are married and become the owner of a business during your marriage, your spouse does not automatically become co-owner of that business.
However, excluding your spouse from ownership, employment, or involvement does not necessarily protect the business from being classified as community property.
Marital Resources Affect The Division Of A Business
If you founded your business before marriage but invested joint marital funds into its growth or success, the increase in the value of the business may be partially or fully considered community property under California divorce laws. Keeping detailed records of any contributions made to the business, such as financial investments, time, or effort, can help clarify the nature of your business and whether part or all of it should be treated as separate property.
Financial Marital Contributions
Imagine yourself as the owner of a restaurant chain. You opened your first few establishments before getting married, classifying your business as separate property. However, after the wedding, you and your spouse invested marital funds into growing the business by purchasing new equipment and opening new locations. Since marital funds were used in growing the business, some of its appreciation may be considered community property.
Maintaining separate bank accounts and financial records for your business and personal finances can help clearly distinguish between community and separate property.
Non-Financial Marital Contributions
In another version of the previous example, the first few locations of your restaurant chain were already successful before you got married. After getting married, the business demands significantly more of your time. As your average workweek hours increase, you become the sole income earner of the household. Your spouse leaves their job to take care of homemaking and parenting responsibilities.
While your spouse did not work directly in the business, or financially contribute to it, California courts will typically recognize raising children, performing domestic labor, and providing time and support as meaningful community efforts that enabled you to work for the success of the business. These indirect or non-financial contributions by your spouse may classify some of the increase in the value of the business as community property.
Legal Strategies To Preserve Control Of Your Business In Divorce
- Talk To A Lawyer: Consult with an experienced business divorce lawyer to discuss how you can take proactive steps to legally protect yourself from the financial risks and long-term setbacks of divorce.
- Prenuptial Agreement: A prenuptial agreement (prenup) is a contract that specifies each individual’s assets and debts before marriage will be treated in the event of divorce or death. Your attorney can draft a prenup specifying that your business, along with any rights to profits generated and any appreciation in its value, are to remain separate property, regardless of whether it generates income or whether your spouse contributes to its growth during marriage. Your prenup can also address business ownership, income rights, intellectual property rights, and claims to future earnings.
- Postnuptial Agreement: If you married as an established business owner without a prenup, or became a business owner after marrying without one, a postnup can protect your business interests. However, postnups are generally only enforceable if established before either spouse contemplates divorce.
Forensic Accounting & Expert Business Valuation Are Crucial In Divorce Settlement
While California community property laws aim for equal division, spouses often negotiate custom settlements out of court.
To secure full ownership of your business, particularly in the absence of a prenup or postnup, you can offer to:
- Pay your spouse cash to buy out their community property interest in the business.
- Exchange other assets of equal value, such as the marital home, real estate, investments, retirement assets, vehicles, or other property.
A non-owner spouse might overvalue the business to get more in the buyout or exchange, while the owner spouse might undervalue it to pay or exchange less.
At Kaspar & Lugay LLP, our attorneys work with experienced forensic accountants and business valuation experts to determine an objective, fair market value of the business based on the date of marriage and date of separation. This gives business owners peace of mind knowing that the resulting settlement is grounded in comprehensive, factual analysis, especially in cases involving complex assets or multiple businesses.
Pereira vs. Van Camp Calculations For Dividing Business Appreciation In Divorce
If the business was formed before marriage, the division will typically be based on how much the business appreciated during the marriage and how much of that appreciation is considered community property.
- The Pereira method is typically used when the appreciation of the business is primarily due to the efforts of the spouse who is the business owner. The pre-marital value of the business is treated as separate property and a reasonable rate of return is applied to it. The increase in the value of the business during marriage is treated as community property.
- The Van Camp method is typically used when the appreciation of the business is primarily due to capital appreciation or external factors, such as favorable market trends. A reasonable salary for the spouse who is the business owner is determined, multiplied by the length of the marriage, and treated as community property. The remaining value of the business is treated as separate property.
Call Kaspar & Lugay LLP To Divorce-Proof Your Business
The significant sacrifices and years of hard work of being a business owner or entrepreneur make it imperative to understand California’s community property laws and protect your interests in the event of divorce. All aspects of your business deserve careful valuation, strategic negotiation, and experienced legal guidance to secure an equitable outcome.
Kaspar & Lugay LLP provides comprehensive legal support for business owners and entrepreneurs navigating divorce. Schedule a consultation with us today to discuss how we can help you protect your business.
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