Protect Startup From Divorce,protect startup

If you own a startup and are preparing to tie the knot, it is important to understand what getting married (or, more specifically, getting divorced) could mean for your business. Even though you owned your startup prior to getting married, there is a very good possibility that your soon-to-be spouse could legitimately claim a share of the business in the event of a divorce.

That is, unless you take steps to protect your startup as your “separate property.”

The same holds true if you start a business while you are married. In fact, if you become a founder during your marriage, there is an even greater chance that your spouse will be able to claim an interest in the business (likely as much as half) if you decide to part ways. If you and your spouse are co-founders, you will need to plan for divorce in much the same way that other business partners plan for the potentiality of irreconcilable differences.

Understanding the Effect of Marriage on Business Ownership

A marriage certificate is the one document that can overrule virtually any other legal instrument. If the law says your spouse is entitled to half of your shared assets (or “marital estate”) in a divorce, the fact that a car, house, or business is titled in your name becomes irrelevant. So, if you think you are protected because you are the sole member of your limited liability company (LLC), you need to think again. Additionally, if you owned your business prior to your marriage, it may qualify as separate property that is not subject to distribution – however this is not universally the case.

The specific rules regarding property rights in a divorce vary from state to state. While there used to be a clear distinction between “equitable distribution” and “community property” states, this line is increasingly becoming blurred. Several states now have property distribution systems that incorporate a blend of equitable distribution and community property principles. And even in states that adhere to one system or the other, spousal property rights still vary broadly from one state to the next. Here are just four examples:

  • Arizona – Arizona is a community property state. In a divorce, the spouses’ marital assets are generally distributed equally.
  • Indiana – Indiana follows a “marital pot” theory which states that all property owned by either or both spouses is subject to division in a divorce. This include assets that would qualify as separate property in other states.
  • New Jersey – New Jersey is an equitable distribution state. In a divorce, the spouses’ marital assets are distributed based on consideration of a list of equitable factors.
  • Texas – Texas is considered a community property state – however it follows an equitable distribution principle. In a divorce, the spouses’ marital assets are to be distributed according to what is “just and right.”

Most other states follow property distribution rules that are similar to one of these four examples. But again, there is very little uniformity across state lines with regard to division of assets in a divorce.

How Can You Protect Your Startup in a Divorce?

1. Protecting Your Startup with a Prenuptial or Postnuptial Agreement

So, if you own (or are thinking about founding) a startup, what can you do to remove any doubt that you are the sole owner? In many cases, the simplest answer is to enter into a prenuptial or postnuptial agreement. But, here too, you need to be careful. While all 50 states now recognize prenuptial agreements, a few states will not enforce postnuptial agreements, and the requirements for creating an enforceable prenup or postnup vary from state to state.

When drafted in compliance with the applicable state law, a prenup or postnup can override the standard property distribution rules that would otherwise apply. So, if you have a valid prenup that addresses ownership of your business, you should not need to worry about what might happen in the event of a divorce. To ensure that your agreement serves its intended purpose, you will want to work directly with an experienced attorney (and not download a “form” agreement online).

2. Following Sound Business and Financial Practices

When you own a startup, you need to keep your business and personal finances separate. You will read this on just about any small business website you visit, and the reason is that segregating your business and personal finances helps preserve the liability shield that comes with forming a corporation or LLC.

But, if you are married, there is another critical reason as well. In the majority of states, both spouses’ personal income becomes marital property that is subject to distribution upon divorce. However, if you keep your business income in your business (and you protect your business as separate property), that income will not be at risk in the event that your marriage comes to an end.

3. Holding Your Business in a Trust

If you hold your business in a trust, will this ensure that your spouse does not have an entitlement to the business in the event of a divorce? Maybe. Trusts are complicated on their own, and using trusts specifically for divorce planning adds another layer of complexity to the equation. This may be an option for you – but before you move forward with forming a trust, you will want to discuss all of your options with an experienced attorney.

4. Using a Buy-Sell Agreement

Can entering into a buy-sell agreement “divorce-proof” your business? Once again, the answer is maybe. The concept is this: You enter into a buy-sell agreement which states that, in the event of an owner’s divorce, the divorcing owner’s shares are subject to purchase by the remaining owners. In other words, the divorce automatically triggers buyout rights, which ensures that your spouse never has a hand in the business.

Of course, for this to work, your co-founders will actually need to buy out your shares. This can lead to a number of complicated questions – most notably: (i) how should your ownership interest be valued, and (ii) when you receive your buyout, are the proceeds then subject to distribution? Additionally, what if your spouse isn’t interested in the business – could your co-founders use your divorce as an excuse to remove you from the company? Similar to using a trust, using a buy-sell agreement can work, but you need to make sure you use it property.

5. When the Co-Founders Are Married

What if your spouse is your co-founder? If you both have equal rights in the business and an equal desire to keep the business in the event of a divorce, your best option will likely be to work out a solution that prevents you from having to fight for ownership and control in court. This can be done through a variety of different methods, including:

  • The company’s organizational documents (i.e., shareholder or member agreement)
  • A prenuptial or postnuptial agreement
  • A buy-sell agreement

In this scenario, the options you have available are limited only by your creativity and your willingness to consider potential alternatives. Should one spouse buy out the other? Should you each retain ownership but only one of you retain control? Should you continue to build the business together, your divorce notwithstanding? Once you decide what you want, then you can choose the legal document that best fits your needs.

Contact Jiah Kim & Associates

If you would like more information about protecting your startup in the event of a divorce, please feel free to schedule a confidential consultation at Jiah Kim & Associates. You can reach us by phone at (646) 389-5065, or book an appointment online now.

This blog post is written for educational and general information purposes only, and does not constitute specific legal advice. You understand that there is no attorney-client relationship between you and the blog publisher. This blog should not be used as a substitute for competent legal advice from a licensed professional attorney in your state.

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