Starting a business with your marital partner may seem like a great idea to some but what happens to your company if you end up in divorce? Karen Holden, founder of A City Law Firm explains who ends up with what.
When setting up a business with your significant other, a divorce is one thing that you often do not anticipate, plan for or want to be a party to. Separating from your partner is a tough thing to do, particularly when kids are involved, but throw in a business and, all of a sudden, things get far more complicated and, in some cases, downright dirty.
It is a rarity when I am approached with a pre or postnuptial agreement, let’s be honest – deciding a shareholder agreement when setting up a business is hardly the most romantic proposition. As a commercial lawyer, I often hear the immortal words, “we are married and in love, we don’t need commercial documents”. Of course, it is a very natural way to feel, and a possible future divorce is not generally the top thing on a person’s mind when setting up a business.
However, divorces do happen and, more often than not, they have a knock-on impact on business. If you are a business owner in partnership with your significant other, what do you need to know?
Decide who owns the IP
When divorcing your business partner, you need to know who owns the Intellectual Property did you transfer this to the business correctly or is this owned by one or both of you personally?
IP can be the business’s main and most valuable asset and could be held to ransom. Without an agreement in place, a costly dispute could arise.
It’s worse with jointly owned IP as someone will have to buy out the other if you want to use it and then you must try and agree who will keep the business, the price and you must have the means to pay for it.
Protect the business
If you do decide to press ahead and protect your business then you will need a founders agreement. This should at the very least, cover these important points:
- Transfer of all IP to the company.
- Set out what happens in the event of a dissolution or dispute.
- Agree restrictive covenants to refrain the departing spouse stealing clients or setting up in direct competition or sharing confidential information.
- Specify who owns what shares and make clear any monies put in by each of you. Keep good accounting records to formally log all sums paid in and withdrawn so it’s transparent and no one can hide anything during the proceedings if the worse happens.
- Make sure that your wills mirror this too in the case of your death it governs where your shares go and how this will be dealt with.
Document cash flow
Often partners don’t document loans given to the business they just put in cash as needed because it is a family business, but this makes for an accounting mess and could lose your invested money if everything just goes into the pool and/or you cannot formally separate those funds.
What if one spouse has not taken a salary or dividend but the other has? Without an agreement permitting this the other party could now lawfully be entitled to their similar payments immediately causing a cashflow/tax headache too.
You might want to sell the business, as there is no cash to fund a dissolution or buy out the other, but you will need the other party’s consent, then you need to agree a price as well as how you repay each other and in what shares. A dispute would put buyers off so you would need to work out a solution between you first.
If assets cannot be sold, an agreement reached or one of you cannot afford to buy the other out the court will be forced to choose a side or worse wind up the company losing you everything you put in.
The equal split
The starting point in family proceedings, if you have no legal documentation, is that the joint assets go into a pool and until you prove otherwise, there will be a 50/50 division.
If a business decision is required and you are 50:50 owners (by law or in default), but cannot agree, its deadlock, this could end up with the company being wound up.
We have acted for many clients in this situation. Often, as is common, one partner plays no real role in the business, but they use joint ownership or joint entitlements as a means to negotiate for more in the divorce.
One client lost everything because he never documented loans to the company. His wife asked for cash to keep the company afloat he simply obliged. On divorce, the monies had not been transparently labelled and everything went into a pool and he lost all his extra investment.
Any business should start off right and get their house in order with clear legal documents. This protects the business, the founders and if a dispute or divorce does come out of the blue it’s not so difficult to unravel and fairly separate out the business interests.