It is not an understatement to say that small and medium sized businesses are the cornerstone of the British economy. For example, according to the Department for Business, Innovation and Skills, there were a record 5.7 million private sector businesses at the start of 2017 and total employment in SMEs was 16.1 million: 60 per cent of all private sector employment in the UK. Many small or medium sized enterprises are owned by members of the same family.
We regularly advise people going through a divorce who own their own small business or have an interest in an SME. There is widespread confusion about the impact of a divorce on the family business. Those concerns are often shared by other members of the family who are not going through the divorce but have a vested interest in any impact on the family business.
In this brief article I hope to answer some of the questions we often hear when advising clients.
Is the business an asset in the divorce process?
A business is an asset and if it has a value then the value of that asset will be taken into account by the courts in dividing the divorcing couple’s assets. A business, however, is not a liquid asset and is treated differently from cash or investments. Extracting value in the form of cash from the business can be difficult and also there will be tax implications. Often a business owned by a spouse will simply provide the family with an income and will not be treated by the court as an asset.
Will I have to sell the business?
It is highly unlikely that a business will be lost or have to be sold as a result of the division of assets within a divorce. Though it has the power to order a sale, the court will be careful not to kill the golden goose. Often the business has funded the parties’ lifestyles, enabled the children to go to private school and paid for luxury holidays and executive vehicles. In rare situations where a spouse has failed to comply with a court order to pay their spouse a lump sum one of the methods of enforcement is the sale of the business.
Will I have to transfer my shares to my spouse?
It is also rare for the court to transfer shares in a limited company, or an interest in a partnership, to a spouse as part of a divorce, if that spouse has had no involvement in the business. Doing so can affect the running of the business, more so if relations have soured. Furthermore, one of the key aims in the divorce process is to effect a clean break between the parties, both financially and personally. If the court does transfer shares to a spouse then it may necessitate a properly negotiated shareholders agreement to minimise post-divorce conflict.
Will the business have to be valued in the divorce process and who pays?
If the business has what is known as a ‘capital value’ and is not treated solely as a producer of income, then the court can appoint an expert accountant to value the business. The costs of the expert are normally shared equally. The costs can vary from between £5000 to £30,000 depending on the size and complexity of the business. If the business owns assets such as real estate then those assets may also need to be valued by a surveyor, meaning these costs may increase. A business valuation is a work of art rather than science, as the true value depends upon what a purchaser is willing to pay for it and in the vast majority of cases the business is private so there are rarely directly comparable examples within the market place to assist the expert. Often the business can also be heavily dependent on the input and ongoing involvement of a key shareholder, so this needs to be taken into account to consider its value as a viable ongoing operation.
My business is valuable but cash poor, how therefore can I be expected to raise cash to pay my spouse?
The valuation of the business will produce a paper asset but the true question the court and the parties will need to consider within negotiations is liquidity: namely the ability of the business to raise cash so one or other of the parties can pay a lump sum as part of a divorce settlement. This can depend on how much surplus cash there is within in the business and other factors such as the ability of the business to borrow. A spouse can be ordered to pay a lump sum or lump sum by instalments, in order to give them time to raise the necessary cash.
The expert can also be asked to consider the sustainable income which the business can generate going forwards, to assist the court in deciding what level of maintenance that spouse should pay their ex-spouse after the divorce if there is insufficient liquidity to raise a lump sum. The court will be careful not to double count the capital value of a business in addition to the income generated by a spouse via the same business when the question of spousal maintenance comes to be considered.
I am a sole trader, does this make a difference?
The court can order a valuation of a business run by an individual as a sole trader or a partnership, just as it can a limited company. The same valuation principles will apply. There will, however, be different considerations that apply to each: in particular the tax consequences for taking money out of each different type of business will be different.
I am a minority shareholder how will the divorce affect me and my other shareholders?
The court can order the valuation of a minority shareholding, just as it can a business solely owned by a spouse or one of which the spouse is the majority shareholder. However, guided by the expert valuer, the court will usually apply a discount to the valuation of a minority shareholding due to the lack of control a minority shareholder they have in the running of the business – unless the company is treated as a ‘quasi-partnership’. This is where there is a close family relationship between shareholders of a private company and the court determines that the minority shareholder would only sell their shares as part of an overall sale of the business.
If there are other shareholders then he will need their cooperation and often their agreement. Having third party shareholders involved will often complicate matters as the articles of association may restrict the transfer of shares. There are also implications for the disclosure of information which belongs to the company as a separate legal entity.
I am a director: can I be ordered to disclose documents belonging to the company?
In short yes. In family proceedings there is a duty of full, frank and clear disclosure. The court will order a spouse to disclose documents that they have power and control over in their position as a director. These documents are often required by the expert when valuing the business. If another director or the company itself objects to the disclosure of documents then they may intervene in the proceedings and the court will consider their objections.
Can the court order a sale or transfer of a property or other fixed asset owned by the business, rather than simply the shares?
If the property or asset concerned (such as plant and machinery) is owned in the name of a limited company then only in very exceptional circumstances can the court order its sale or transfer, even where the company is owned by one of the parties to the marriage.
Will the expert investigate misconduct?
It is important for spouses to be aware that the jointly instructed expert acts more like a ferret than a bloodhound. They are not there to investigate wrongdoings: instead their role to give a broad opinion of the valuation and liquidity of the business. If a spouse who has no involvement in the business suspects their spouse of diverting income or playing down success and profitability, and is not happy with the joint expert report, they can seek permission to involve an expert instructed solely by them. In those circumstances the Court will expect there to be good evidence that the jointly instructed expert’s conclusions are wide of the mark. Before this occurs, each party has the opportunity to ask questions about the report and see if they change their conclusions as a result. Stowe Family Law is unique amongst law firms which specialise in this field in having its own department of forensic accountants available to assist with this type of exercise.
I started my business before I met my spouse: will I be given credit for this within the divorce process?
The general principle is the court will share equally assets built up during the marriage and that can include a business. As with other assets, if the business is one that a spouse owned before the parties began their relationship, then arguments may be available to ring fence some or all of it from division in divorce or support a departure from equality.
This may complicate the valuation exercise, as the expert may need to value the business both at the time of the commencement of a settled relationship and also at the time of the divorce, thereby increasing the costs of the exercise. Equally arguments can be employed to ring fence a proportion of the value of the business built up following separation. Whether the court will give a spouse credit for pre- or post-acquired value in this way will depend on whether the other spouse’s financial needs can be met without recourse to the asset value of the business. Otherwise those needs have priority.