Ep. 21 - How are businesses dealt with on divorce

Jen: In this episode, we're going to look at finances on divorce with a specific focus on cases that involve businesses. We're joined by Andrew Moore, a Principal Associate in our Manchester team.

Andrew is a family law solicitor and mediator, and he leads the family and children team’s business sector across all of our offices. Andrew specialises in financial settlements following divorce, often working closely with our firm's corporate team, to provide a holistic service to businesses and their owners if they are going through a divorce.

Thanks for joining us. 

Andrew: Thanks for having me.

Tim: So in terms of the discussion today, we're going to focus on one particular type of business and that's a limited company. There are some key points that it's worth understanding and bearing in mind during this episode.

The first is that a limited company is a type of business structure where the company is legally separate from the people who own it and run it. The second is that in terms of ownership, a limited company is owned by its shareholders. Each shareholder owns a portion of the company represented by their shares.

And the third point is that a company is managed by the directors. The directors are responsible for the day-to-day operations and for making strategic decisions. Sometimes the directors can also be the shareholders, but not necessarily.

So with that all in mind, let's start by having a think and speaking to Andy about cases that involve businesses and how they may be dealt with on divorce.

So Andy, can you start off by just telling us about how business might come up in the divorce case? 

Andrew: Of course. When businesses come up in divorce cases, it normally is because one or both of the parties to the marriage are the shareholders of family or owner-managed businesses. In fact, I see it all the time and it's really common for spouses and wider family members to be involved in the businesses.

In some cases, family members hold key roles and are indispensable to the business and its future success. In others, it would not be unfair to say that their ownership and involvement in the business is probably more focused on the tax-sufficient extraction of profit for the benefit of the family. 

Whether a spouse is involved in a business or not, the relevancy of a business in a divorce case is that it normally does provide the main or sole income stream for the family. It could also be a source of capital to meet the financial needs of the family post-divorce.

In my practice, I regularly see the business as an asset which is worth more than all of the other family assets combined. So, inevitably become a key focus of the parties when they come to discuss and determine how all of their assets will be shared between them. 

Parties will need to consider who will retain the business or whether it should be sold. Can both parties remain working in the business and continue to take an income or receive dividends if they've got a shareholding? Now, I often come across multi-generational businesses where three generations, for example, of the family of shareholders and involved in those cases, there are considerable emotional ties to the business and the family see their ownership of the business as one of custodian for the next generation. 

Those cases and how the court might approach how the business should be factored into settlement may be very different to, say, a brand new tech business where the focus of the shareholders is to license a product, grow quickly, and cash out quickly.

Jen: That's really interesting, Andy, and I think it's always worth bearing in mind that sort of the way in which the business has grown, evolved, and developed can actually be quite influential in then how people perceive that business. As and when they're going through, through their divorce. 

What do you tend to find that your client's priorities are as either the business owner or perhaps the spouse that isn't the leading person?

Andrew: Bit of a cop-out to say it depends. You know, no business is the same. No business owner is the same. And in every case, we do need to explore what our clients' priorities are. So, if you do have a multi-generational company, well then the likelihood is likely to be that the business owner will want to protect that business at all costs for the benefit of other family members. If the party's children are already involved in the business, a divorce might be a good catalyst for bringing forward succession planning. 

Non-business owners might not be as concerned about sharing in the full value of the business if he or she knows their children will be receiving a shareholding. Now, there are those business owners, and I've had lots of them over the years, where they have unwavering faith in their business, and they are adamant that they want to retain all of the shares, and their spouse can have everything else, even if that does not fairly share the risk, and liquidity of the family's assets and leaves the business owner in rented accommodation. 

Or you might have a business owner who is approaching retirement. Or to use my example, you've got an entrepreneur who's looking to quickly grow his or her business before moving on to the next venture. In those cases, their priority might be an immediate or delayed sale. With either a predetermined figure or percentage of net sale proceeds being paid to their spouse. In those cases, the benefit is the risk of the business venture or the eventual sale price being shared as are non-business assets. 

As long as you're not asking a judge to make the decision, there really is a loss of opportunity to be creative in these type of cases. Clients at Mills & Reeve really do benefit from having private client and corporate teams on hand to provide both personal and the business advice and look at all the various planning opportunities. And we also work really closely with company directors, financial directors, and external accountants too, just so we can make sure all of that planning dovetails well. 

Tim: And so in previous episodes, we've explained that the first step when you're looking at the finances on divorce is to understand what there is and to understand the value of the assets before moving on to the second stage, which is talking about the division.

From what you've been saying, I can foresee scenarios where the value of the company is either disputed for maybe in reasons of self-interest, f someone's wanting to keep a company, they may, the true self-interest want to value that lower. And if someone's selling their share or normally selling their share, the business, they may want the value to be as high as possible. 

But I can also foresee situations where it's just very difficult. Even if everyone's working together and wanting to try and agree a value, it can be more difficult than understanding what's in a pension or what's in a bank account. So can you talk to us a bit about how you deal with that and whether there are experts that can help? What's the process?

Andrew: Well, with all cases, there has to be some financial disclosure, as we explained, Tim. So, for me, will be completed and ordinarily a business owner would put a figure for what they think the value of their business is within that disclosure. 

But given the complexity and value of most cases, it is commonplace to have an expert. And that expert might be asked to evaluate the business. They might be asked to advise upon liquidity to fund the settlement, tax that would be incurred on extraction. And the sustainable income which might be able to pay maintenance for the future. 

Now normally that expert would be a forensic accountant. And they'll be instructed by both parties as a single joint expert. So you don't normally go and get your own expert to inform at value. But I've got to say that both parties can't have their own accountant in the background. We call those shadow accountants. And they might help frame the instruction of the single joint expert, check the report, help with questions, and also to advise on options. 

Advice from a shadow accountant might mean you do not need to get a single joint expert and save on the cost of that instruction if a fair valuation has been advocated by the business owner and that can be agreed. It may also be the case that other business assets need to be valued as well.

So to use one example, if you've got a care home business, well, the care home building itself might need to be valued, and factored into the accountancy valuation. If the company is just a structure which owns property, well then probably only the property needs to be valued in those circumstances. 

I often also see commercial premises in business owner pensions. So, the property may need to be valued and factored into the pension or divorce expert report. And that will advise upon pension sharing. It might be worth managing listeners' expectations around business valuations, though. 

These aren't really huge investigations where every single sale and purchase is reviewed or where machinery and tools are separately valued. The experts will be reliant on lots of documentation from the company, such as audited and management accounts. Without a smoking gun or considerable concern that something underhand is happening in the business, the courts aren't going to direct an expert report that goes beyond, you know, the headline valuation, which is needed for core purposes. 

Now, when we're talking about valuations for businesses, we're really not talking about listed companies like Apple or Amazon, so if you've got shares in those companies, you don't need to get a valuation. You'll be able to find that information easily at any minute of the day and shares can be sold quickly. For those owners, however, they might want to consider their tax positions if they need to dispose of shares. 

Jen: So, as a bit of a recap, then you will go through the formal process of disclosure, potentially getting some expert input in terms of the actual value of the business. People are hopefully taking legal advice and starting to think creatively about how they might want to structure their settlement, looking at the different options, getting input from the accountants. 

But ultimately, if the parties can't agree what should happen, how would a court look at a business? Are there particular considerations? What powers would a court have in relation to the business, bearing in mind that it is a separate asset to the parties themselves?

Andrew: So it's a good question, Jen, and it's probably worth starting with the court's powers and then I'll circle back to consider how readily the courts use them and the outcomes I see the most. A shareholding is a property, so the courts have the power to order the shareholder to transfer their shareholding to a spouse, or even order them to sell their shareholding to a third party. 

The court could order the business owner to pay a lump sum to their spouse, and that might only be able to be generated by utilising the assets of the business. That could include maybe extraction of any perceived surplus funds in the business or borrowing against company assets and extracting that borrowing. If both spouses have a shareholding, then a company purchase of their own shares might be a tax-efficient route to extracting capital from the company in exchange for the exiting spouse's shares. 

The court could also order the business owner to pay maintenance to their ex-spouse from their taxed income, bonus or dividends.

So circling back to what the court in reality are likely to do, and I think business owners will be pleased to hear that the least likely outcome is that the court orders the sale of the company as it may impact on many other people. Not just the divorcing couple. So when I'm thinking about that, I'm thinking of other generations within business, employees, or perhaps other companies in the supply chain. 

If the business is the main income stream as well for the family, and the couple are not close to retirement with pensions to fall back on, then a sale really is going to be unlikely. The court are also unlikely to transfer a shareholding to a spouse or leave both spouses in the business together unless there really is a high degree of trust between them and both really want that outcome. 

One reason for that I have seen is that it's very hard indeed to protect the interests, those interests being the underlying value of the shareholding or ensuring a fair distribution of dividends of someone who is going to be a minority shareholder. The court doesn't normally have the business acumen, time, or inclination, or perhaps jurisdiction to get involved with the drafting of the company documentation, which really is required to protect an incoming or minority shareholder.

What is more likely in these cases that I, and what I've seen on a regular basis and also those reports to by the courts is that one business owner will retain the business. And they either have to transfer the lion's share or all of the non-business assets to their spouse. And they also have to extract capital from the business to fund that settlement. 

They may have to pay maintenance as well. Paying maintenance might in effect actually be sharing the value of the business anyway if its true value is its income stream. It probably would be amiss of me not to plug two important planning opportunities for family businesses at this juncture, both of which will reduce the risk and impact of divorce on business. 

The first is having fit for purpose company documentation, which is what they should have. Primarily with talking about the articles of association and shareholders agreement. Business owners should think about pre-emption rights, so upon any relationship breakdown, shares are immediately transferred back to the business. Those documents might propose valuation methodologies as well and procedures for an exiting director and or shareholder. 

The other document to give a lot of thought to is a pre- or post-nuptial agreement. The value of them really can't be overstated. Although they're not binding on the courts, they are hugely influential. So, for business owners, they could be used to ring fence the value of the business before they marry and, on the board, certainly share the growth in value of the business. That is referable to the marriage or they could be used to seek to exclude the business altogether from the financial settlement. That might be a fair and appropriate option if you have a generational company. The shareholders are in effect just custodians of the shares for the next generation. 

Jen: Brilliant. Thank you, Andy. That's really helpful. And I think the way in which you've described all of these added bolt-ons to the family law advice and the fact that needing to possibly prepare extra documents from the company's perspective, and how the courts can't necessarily always grapple with that extra task. 

Those points really lead me on to asking about the opportunities for non-court dispute resolution. Do you think that that's something that perhaps suits cases that have got businesses involved? 

Andrew: Very much so. Non-court dispute resolution approaches can involve legal teams or accountants being present and they can really support the decision making and help explore innovative solutions for the benefit of the family. These processes are quicker and normally a lot less expensive than court-based dispute resolution as well. 

Now, if I was a business owner, I wouldn't really want to go anywhere near the courts. Many family law judges do not have the business acumen to understand complex business structures or issues and are likely to take the most simplest of routes, which might not be the outcome the business owner needs. There is also, I have to say, a risk of adverse publicity or sensitive company information being reported in the public domain as journalists are allowed into hearings. They can report some of the details of the case. 

If the parties are really far apart in their proposals and a third party really needs to make a decision for the couple, then I would implore listeners to consider arbitration. It has the benefits of speed and privacy, but it has the benefit of you being able to choose your arbitrator, your judge for the day, who has the necessary experience on business cases. 

Tim: And that's a wonderful time just to mention some other episodes that we have available. Andy's mentioned nuptial agreements, which has a separate episode as well as arbitration. And I also just wanted to mention that farming cases often include businesses within the farm structure and we have an episode too.

So we've heard how central business can be to divorce and he's explained how it can impact income. It can impact the capital or the cash available for the family. And it can also impact pensions with often commercial property that's related to the business being held within pension. 

So it's clearly a vital issue for both parties to understand and feel comfortable with. So just to tie things up, Andy, can you end with your top tip for a client who is thinking about getting divorced and knows that there is a business involved?

Andrew: I think the top tip, and it's completely self-serving, is to choose a solicitor who understands businesses, you know, at a firm that can deliver all of that holistic planning for the business and the individual. That collaboration between family teams, private client teams, corporate teams is so central. You know, really are going to be the best team for business owners. And make sure the family and the family finances and particularly the business are in a good place for the future. 

Jen: And I think that's a really valuable point to bear in mind, not just if you have the situation of one spouse running a business and they want to look at what options they might have. But I also think it's quite important if you have a situation where one of the spouses has had nothing to do with the business. And they actually need to understand what is going on, what their spouse has been up to in, in setting up this company.

And particularly if you've got a lack of trust, going to a lawyer that knows the best questions to ask, can ask them in a way that's sort of proportionate and helpful in the circumstances, can be a really positive way of getting a divorce started rather than coming for a position of not understanding the business. Asking every single question just in case it's going to help you and then suddenly finding that legal costs have run away with you, for example. 

Andrew: Very much so. 

Tim: Thank you so much for joining us, Andy, and giving us such a clear summary of how businesses could impact divorce. As always, if you have any questions or any suggestions for future episodes, then please contact us via our social media.