Companies often caught in middle when owners divorce

By Joyce M. Rosenberg
Associated Press

NEW YORK — When a small-business owner goes through a divorce fight, it's often more than a personal ordeal — the company can become part of the battle.

A difficult divorce can even put a business at risk if the owner is forced to pay a huge sum of money to a former spouse.

When Dave Reed shut his high-tech company down last year, "one of the factors was the huge amount of money I had to lay out for my ex-wife," he said.

Reed, of Coto de Caza, Calif., founded the business with a partner in 1988 and got married three years later. After he and his wife started divorce proceedings in 1998, she wanted a share of the business. Reed ended up agreeing to pay an amount he describes as being in "the high six figures." The payments and the sagging economy helped bring the business down, he said.

Violet Woodhouse, an attorney and financial planner in Newport Beach, Calif., has advised company owners going through divorce.

"I've seen businesses go down and close" because of the financial stress on the company, she said.

Sometimes when couples fight over a company, it's because they started the business together or both worked in it, and each one wants it. The fight becomes a custody battle, because few couples are able to work together after a breakup. In the end, one spouse will likely buy out the other.

A buyout is also likely when only one of the spouses started or was involved in the business but it's the major asset held by the couple. That's often the case with a new or fairly new business, since entrepreneurs tend to invest as much as possible into the company to help it grow.

In such a case, there might be few other assets that can be used in a settlement, and the spouse who retains the business will have to rely on the company's cash flow to make the payments. That's where the company can be jeopardized.

"You have all the normal expenses of operating a business, such as marketing and labor, and you have to add in making a multimillion dollar purchase," said Dana Barfield, president of The Barfield Group, a financial planning firm in Richardson, Texas. He estimated that a business would have to generate $50,000 to $60,000 a month just to enable a former spouse to pay off a $3 million debt over five years.

A divorce fight can also have a deleterious effect on employees, particularly when both spouses are involved in the firm.

"It's almost natural to try to have people take sides, and so the staff gets pulled into it," Woodhouse said. "You destroy each other and, in that process, you're demoralizing the staff."

The result is that employees might leave, either because they're worried about their jobs or they don't want to work in an unpleasant atmosphere.

Another risk involves company secrets. Does a spouse have knowledge about the business that, if revealed to competitors, would damage it?

And more complications can arise when there are other shareholders or partners in the business. Not only do they feel the strain, but Woodhouse noted that the disclosure of information about the business during the divorce process "can go into the privacy of other individuals."

One of the biggest battles is likely to be over what the company is worth. That will determine how much one party must pay the other in a settlement.

Both sides bring in their own experts to place a value on the business. When the two sides come up with vastly different figures, the valuation itself might be litigated. All the while, money is going to lawyers — and the business is likely to suffer further.

"It is a tremendous opportunity for everybody to lose to a very large degree," Barfield said.

Attorneys say there are other considerations when settling with a spouse.

Alan Toback of the Chicago law firm Lake, Toback & Yavitz, noted that if one of the spouses was employed by the business and was well-compensated, he or she might not be entitled to a large share of the business.

Conversely, if a spouse made a big contribution toward the growth of the business and wasn't compensated, he or she might rightly demand a large settlement.

"Each case is different and decided on its own merits," Toback said.

Sometimes, when couples are unable to reach an agreement, a court orders the business to be sold. But, Barfield, noted, that can turn into a fire sale. If the judge sets a deadline for a sale, buyers will wait until the last minute, knowing an anxious owner is likely to lower the price to satisfy the court's order.

One way to try to avoid problems is to sign a prenuptial agreement if the business exists at the time of the marriage, or a postnuptial agreement if the business is started afterward. Such an agreement can set forth how a business will be dealt with if there is a divorce, in much the same way that agreements between business partners spell out what will happen to a company if there is a death or departure.

But these documents can be problematic. Reed said he had a prenuptial agreement, but it was declared invalid by the court.

And Woodhouse noted that courts might look askance at postnuptial agreements, questioning whether one spouse might have used undue influence over the other.