For many entrepreneurs, a closely held business feels like an extension of one’s self, not just a business. That’s why wondering how your closely held business interest will be handled in your divorce can be a source of considerable stress. But there is little cause for concern. Please continue reading below to get up to speed on the basics of divorce and its effects on closely held businesses.
Martial Property Basics
Texas is one of the few states that recognizes two forms of marital property: community property and separate property. Though the characterization of assets can, at times, become complicated, in most cases spouses’ property will be considered community property unless it was gifted to a spouse or was owned by a spouse before the marriage. For an in-depth discussion of property characterizations, please follow this link. After all the property is characterized as either separate property or community property, the court will make a “just and right” division of all community property between the spouses.
Determining the characterization of assets such as a car or the house is often a straightforward process, but how will the court determine the characterization of an ownership interest in a business?
Perhaps the most straightforward business entity is the partnership. Typically the choice for “lean” entrepreneurs, Texas has well-developed legal principles for partnerships. First, it’s important to understand the difference between the partnership interest and partnership assets.
A partnership asset is property owned by the partnership itself, not the individual partners. As a note, a partnership can hold legal title to assets even without title formalities. Because partnership assets are not held by either spouse, they cannot be characterized as community or separate property.
A partnership interest is one’s right to share in the profits and losses of a partnership. A spouse’s partnership interest will be characterized as either community or separate property depending on whether the partnership was formed prior to or during the marriage – a question which may be highly contested. Regardless of whether a partnership interest is community or separate property, any distributions made during the marriage will be community property, and are therefore subject to division.
Other Business Entities
A spouse’s closely held business may also come in the form of a limited liability company or a corporation. Due to the increased formalities that accompany these types of entities, questions surrounding the property characterization of their assets are generally easier to resolve than those of partnerships. For example, the title to a fleet of vehicles owned by Local Biz, LLC will clearly show the company as the owner, and is therefore not subject to division in a divorce. Similar to the analysis of partnership interests above, the characterization of the ownership interest of a company will depend on when the legal entity came into existence – for LLCs and corporations, that is when the entity’s formation documents were filed with the Texas Secretary of State. Please note that the characterization of the ownership interest will always look to the time of filing. Consequently, an informal partnership that later became a corporation or LLC will be characterized according to the filing date of the entity and not when the partnership began.
While the date of formation resolves the characterization question for most businesses, the issue of seed money may also need to be considered. According to Texas law, when a portion of a company’s seed money is separate property, an equal proportion of the company’s current value will be considered separate property. For example, say a couple contributed $10,000 of their community property to a joint venture. The husband also contributed $10,000 of his separate property that had been gifted to him by his father. The company later grew to a valuation of $1,000,000. Based on the initial capital contributions, a court would find the company to be 50% the husband’s separate property and 50% the marital estate’s community property. If this divorce was a 50/50 division, the court would subsequently award the husband 75% of the business (his 50% separate property share and his half of the 50% community property share).
For a detailed look at how your business will factor into your divorce, please download our free eBook, The Business Breakup.
If you or your spouse are considering a divorce and you are concerned about the future of your closely held business, please contact us to speak with an experienced lawyer today.
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