A buy/sell agreement is one strategy for maintaining control of a family business in the event of a divorce.
If an airline’s flights crashed 50 percent of the time, would you still fly on that airline? Well, according to some statistics, about 50 percent of all marriages end in divorce. That’s not necessarily reason enough for most people to avoid getting married, but it is reason enough for smart family business owners to plan for the potential consequences of a child’s divorce.
When a couple exchanges wedding vows, laws kick in giving each partner rights to the other’s assets. Like it or not, the bride and groom (and their folks, if there are family assets) just boarded Maybe Divorce Airlines.
To be truly effective, any strategies for protecting the family business (and the family wealth) should be in place well before the divorce devil rears its ugly head. A prenuptial agreement is an easy way to protect family wealth, but many times one or both partners refuse to sign one. This makes it critical that the business owner create his own travel insurance for a trip with such odds of survival. A lifetime estate plan is essential, and it’s what we recommend for a typical business owner like Joe.
Joe owns Success Co. and eventually wants to transfer the business to his oldest son, Sam, who works for the company but does not currently own any stock in it. Sam is engaged to be married to Sue, and as long as any stock that Sam will eventually own is considered “nonmarital property” from the start, it will be safe from Sue in the event that they divorce someday. She would only have an interest in “marital property,” which can only be created after they marry.
So let’s say Sam and Sue do marry, and he later acquires stock in Success Co. Does that stock then become marital property or does it remain nonmarital property? Well, it depends.
The stock could be considered nonmarital property: 1) if Sam owned it prior to the marriage; 2) if he received the stock after marriage as a gift; 3) if he received it after marriage through inheritance; or 4) if he bought the stock after he was married with money earned by him before the marriage, or with money received as a gift or inheritance before or after marriage. (This fourth way may be tough to prove in court if Sam’s wife sues for divorce, however.)
The one simple trick that guarantees Sam will be to keep all assets after a divorce: Do not create marital property.
Let’s say, however, that Sam receives a stock bonus from Success Co. after his marriage to Sue. That stock will be considered marital property. And what happens to marital property in a divorce? That’s often determined by an expensive valuation war followed by a court order to pay a court-fixed amount to the ex-spouse.
Joe and other business owners may have little or no control over what happens in their adult children’s personal lives, but they can have control over what happens to their own businesses. One way of exercising this control is with a well-drawn buy/sell agreement that fixes the stock price for all stockholders in the company and protects these shareholders from ex-spouses.
A well-drafted buy/sell agreement will determine exactly how, and under what terms and conditions, the transfer of an ownership stake in a business will take place, including in the event of the divorce of one of the owners of such a stake. It should stipulate specific procedures for transferring, buying and selling ownership interests, as well as include restrictions on the ability of ex-spouses to have any ownership interests at all in the company.
A buy/sell agreement can accomplish any number of goals, including:
• prohibit a stockholder from transferring and/or selling stock to other parties without the consent of the other stockholders;
• automatically convert business assets like voting stock into non-voting stock upon a triggering event, such as divorce;
• provide other stockholders with the right of first refusal to buy the stock from any departing owner, his or her estate, or his or her ex-spouse;
• require all stockholders to have an acceptable prenuptial agreement in place before marriage that would require the spouse to waive any and all rights to any ownership interest in the business in the event of a divorce.
To summarize, for a business owner like Joe, transferring assets to children is a smart way to save on taxes and to preserve wealth in the event of an adult child’s divorce—if the assets can be transferred to that child as nonmarital property. Strategies like buy/sell agreements are essential tools for controlling what happens to a business after it is passed on to the next generation. However, measures like this must be in place well before a triggering event like a divorce or it will be too late for them to be effective. Comprehensive estate plans, including lifetime plans, are essential.