It takes a special kind of individual to start a business. An entrepreneur must have a vision and a burning desire to see that vision realized. An entrepreneur must be willing to take substantial risks in moving the enterprise forward and must have a constitution to bear with disappointments and setbacks without giving up.
As Winston Churchill famously opined, “Success consists of going from failure to failure without loss of enthusiasm.” Unfortunately, since entrepreneurs are a rare breed, they’re very often wedded to individuals who do not share their passion. Over time, these spouses lose enthusiasm, get worn down by strings of disappointments, and often opt out, not just of the business but of the marriage. Let’s explore the ways in which pursuing a business startup can add stress to a marriage and how, in the worst-case scenario, to protect the business from the ravages of divorce.
How Pursuing the American Dream Can Invite the Nightmare of Divorce
In some cases, starting a business is similar to having an extramarital affair. Spouse A, the entrepreneur, develops a fascination, not with a paramour but an idea. That idea haunts Spouse A during time with Spouse B. Thus, Spouse A is not present to Spouse B. At first, Spouse B is not threatened by “the dream,” and may be incredibly supportive. The two might work side-by-side to advance the enterprise. They might agree to use marital funds to finance various stages of development. However, if the business does not move forward on schedule, Spouse B can start to have second thoughts. These often include misgivings over continuing to pour money into a stagnant project. Spouse B can also become resentful of the time Spouse A spends on the business, to the detriment of the family. Spouse B gradually comes to view the business as a rival for Spouse A’s affection.
Naturally, the tension between spouses will be greater when the business simply limps along without hinting at an adequate return for their many sacrifices. Spouse B will keep an ongoing tally of the amenities the family has done without so that the business can plod forward. Even with successful startups, the loss of Spouse A's attention, affection, and physical presence can outweigh whatever benefits the couple might be enjoying from the business.
Eventually, Spouse A’s singular focus on getting the business up and running has caused a rift that won’t be healed. Spouse B is tired of feeling neglected and is ready to move on. Ironically, this moment often comes just as the business begins to flourish. In fact, in many cases, the financial success of the business provides the impetus for the neglected spouse to file for divorce.
The Cruel Toll of Divorce on Entrepreneurs
At this point, you might be tempted to think, “Well, Spouse A lost a marriage, but at least gets to keep a thriving business.” Yet, that’s not always the case. For numerous reasons, as discussed below, courts often award spouses a substantial equity interest in their mates' startups. Two of the factors that judges must apply in property division are a spouse’s contributions to the home and to the other spouse’s career success. As examples, we can look at a couple of high-profile divorces. After divorcing Microsoft founder Bill Gates, Melinda Gates received a settlement of $76 billion. This certainly did not reflect her actual, market-based, value-added contributions to the software giant's success. Likewise, when MacKenzie Bezos divorced Amazon founder Jeff Bezos, she received a payout of $38.3 billion. In both of these cases, the business founders kept control of their enterprise, but they paid a hefty price for doing so.
Equitable Distribution and the Entrepreneur
New York is an equitable distribution state, which means that each spouse is entitled to a fair, though not necessarily equal, portion of the marital estate. It is a long-standing principle of divorce that spouses who provide support (monetary, emotional, etc.) that contributes to the professional success of the other spouse are entitled to share in that bounty. Thus, the wife who supports the husband while he pursues his medical degree has an equitable interest in the earning power of that higher degree. This principle applies to a startup business, when a spouse has made sacrifices for its success. A court will see that business as a marital asset, subject to equitable distribution, unless the entrepreneurial spouse has taken pains to prevent that from happening.
Safeguarding Your Business From Equitable Distribution
There are two basic strategies for divorce-proofing a small business. First, prevent it from being considered a marital asset. Second, minimize any equitable claim from the other spouse. Let’s break those down.
You can keep a small business out of the marital estate by defining it as the separate property of the entrepreneurial spouse:
- Execute a postnuptial agreement — If you founded the business before your marriage, you can negotiate a prenup that keeps the company separate. But if you are married, you can still draw up a contract. Just be aware that a postnuptial agreement requires consideration in order to be binding, so you must make some kind of concession to your spouse.
- Incorporate your business — Incorporation creates a business entity separate from your personal and marital assets. You can add another layer of protection by placing the incorporated entity in a living trust.
- Keep business finances separate — Once you’ve incorporated, you want to keep the company’s earnings separate from your earnings, and the company’s tax filings separate from your own. You don’t want all of the company’s revenue flowing into your personal income, especially if you are filing taxes jointly with your spouse.
- Define all uses of marital funds as a loan — Even if you declare the business separate, a court could find that it is marital property if you don’t continuously treat it as separate property. Therefore, if you are fueling your enterprise with household cash, you must draw up loan papers to document that you are borrowing from the marital estate and intend to repay the funds. The more businesslike this transaction, e.g., including interest and a repayment schedule, the more persuasive this evidence will be in court.
- Compensate Spouse B — Any personal or professional contributions that Spouse B makes to Spouse A’s business builds a case for it being a joint, marital venture. Many entrepreneurs lean on their spouses for assistance with job tasks, whether it be marketing, website construction, trademark design, or stuffing envelopes. If you do not compensate your helpful spouse at market level for those services, you are allowing your spouse to build an equitable stake in your company. If you cannot afford to make payments, at least document the services, assign a value and make a payment promise.
- Don’t hire your spouse — If you have to pay market value for services, it's tempting to just hire your spouse. Unfortunately, this opens the door to claims of under-compensation for contributions beyond the job description, which again raises the specter of equity in the company.
However, even the cleanest, most thorough separation of a business from the marital estate won’t provide 100 percent protection. But you can avoid surrendering a substantial portion that threatens your control of the company or jeopardizes its future. It’s also important to speak to an attorney as soon as you suspect divorce might be coming. You could receive valuable advice on the necessary steps to protect your business.
If you have questions about your rights to a spouse-owned business, an experienced divorce lawyer at Bikel Rosenthal & Schanfield, LLP can assess your situation. We can offer advice on decisive steps you can take to strengthen your position. Call us today.