The breakdown of a marriage or civil partnership is always difficult, but when you also own a business, it can put even greater emotional and financial stress on the parties involved.
Protect your business from the start
The best way to protect yourself, and your business, in the event of a divorce, is to have a pre-nuptial agreement, or post-nuptial agreement in place already. Such an agreement can set out what should happen to the business in the event of a separation and can help ensure that, were you to separate, you will have a better chance of retaining the business unchallenged. This is particularly relevant if you are significantly more involved with the business than your spouse or civil partner – for example, you have taken on the business from a family member (for example, you take over your parents’ business), or you started the business prior to the marriage. These are not the only reasons why you might choose to have a pre-nuptial agreement, or post-nuptial agreement, however. It may be, for example, that you and your spouse or civil partner agree that the business, even if started during the marriage, should pass as a whole to your children in time and that, in the event of a divorce, the business should be excluded to ensure that this is the case.
Regardless of the reason, pre-nuptial and post-nuptial agreements are the best form of protection for your business. Since the case of Radmacher in 2010, while not legally binding, the Court considers such agreements to be “highly persuasive”, provided that they have been entered into in the right way – steps that can given them more weight include:
- In relation to pre-nuptial agreements, entering into the agreement more than 28 days ahead of the wedding;
- Exchanging financial disclosure ahead of the agreement being entered into; and
- Each party to the agreement taking independent legal advice in advance.
Practical forms of protection if separating
Whether or not you have a pre-nuptial or post-nuptial agreement in place, the most important piece of advice in the event of you separating from your spouse or civil partner, is to try not to change the status quo or to act hastily, and certainly not without first taking legal advice.
If you and your spouse or civil partner are in business together, it might be tempting to resign as an employee of the business, and to walk away from a potentially acrimonious situation. There are many benefits for both parties, as business owners, and indeed for the business itself, to both individuals remaining as employees of the business, if this is already the case – even if one party has minimal day to day involvement with the business. If, during the divorce process, one party’s shares are to be transferred to the other, or to be bought by the company, then it may trigger a Capital Gains Tax liability. Business Asset Disposal Relief (previously Entrepreneur’s Relief) may be available on this transfer or buyback, provided that the exiting spouse has been an employee for 12 months prior to the sale. If a party resigns as an employee in advance, the opportunity for this form of tax relief is lost.
During the divorce process, it can also be tempting to reduce your salary or dividend payments to try to impact financial proceedings. As part of the resolution of finances on divorce, the company may well need to be valued (see below), and any scrutiny of the accounts will reveal actions taken in respect of the income each spouse or civil partner receives from the business, and this will need to be justified. It may be that payments out of the business have to be reduced during proceedings for reasons outside of the divorce, and this is fine, provided that it is done upon receipt of legal and financial advice, and is done so transparently.
If your business has shareholders or employees outside of the marriage, it is even more important that significant changes aren’t made on divorce without considerable thought first. Employees can become nervous when news of a divorce breaks, so it is important to ensure that the business won’t be dealt with rashly, or in a way which might compromise their role.
It is essential that you seek legal advice as early as possible, to ensure that neither of you take steps which could be detrimental, either to the business or to you (both) as business owners.
The legal process
Financial Disclosure
In the event of a separation, the first step will be an exchange of financial disclosure. For business owners, the minimum disclosure is likely to be two sets of accounts for the business and a copy of personal tax returns for the last two years, as well as a P60, if relevant. It may be that further disclosure is requested thereafter and, unless there is good reason, it is often helpful to provide that disclosure in order to resolve any disputes and bring about a resolution as swiftly as possible.
Valuation
Following the exchange of financial disclosure, it is likely that the business will need to be valued. In the vast majority of cases, this will need to be done by a single joint expert, appointed by both parties following a joint letter of instruction, but, if there has been a recent valuation, it may be that this can be approved by your spouse or civil partner if it is fair and reasonable.
The business can be valued in a number of ways, depending on the nature of the business. For example –
- A valuation of the assets held by the business; or
- A valuation of the maintainable earnings of the business.
In some cases, it will be necessary for goodwill to be taken into account. In which case, the approach often taken to business valuations in divorce proceedings is as set out by the International Valuation Standards (IVS) 2022, which provides the following definition to market value:
“the estimated amount for which an asset or liability should exchange on the valuation date between a willing buyer and a willing seller in an arm’s length transaction, after proper marketing and where the parties had each acted knowledgeably, prudently and without compulsion”
It will not always be appropriate for goodwill to be taken into account, however. In the case of CG v SG [2023] EWHC 942 (Fam) the husband started the business with two other partners, but, by the time of the hearing, he was the sole partner, albeit he was not entitled to all the profit. Around 90% of the fees were attributable to his work, and his entitlement to the profit would rise from 95%, to 100%, once the other investors had been repaid. The judge concluded that the business was a “singleton” business, whose success was dependent on the husband alone. The business could only be sold with the husband’s continued, dominant involvement. In other words, the business and the husband were not mutually exclusive – there was no goodwill attached to the LLP as a separate entity.
Discounting
It may be appropriate for a discount to be applied to the value of the business – for example, in the event that you have a minority shareholding in the business (ie. you own less than 50% of the shares in a company that have noting rights attached) or the shareholding is illiquid (ie. not easy to convert into cash without losing value). In the landmark case of Miller v Miller; McFarlane v McFarlane [2006], the judge described business valuations as “often a matter of opinion on which experts differ” – essentially, valuations are often an art rather than a science, and the issue of discounting plays a major part in that – and, in the case of Versteegh v Versteegh [2018], the Court explored the difficulty of valuing the future liquidity of a company, and eventually concluded that a 13% discount was appropriate in light of post-Brexit uncertainty.
The Court may also apply a discount for the business being a ‘risky’ asset, compared to a ‘copper-bottomed’ asset, such as property or cash. In general, a Court would expect that the issue of risk has been taken into account by the expert valuation, but a discount can sometimes be appropriate. In the case of E v L [2021] EWFC 60 (Fam) the Court applied a 45% discount to the valuation calculated by the accountant, and more can be read about that case here and here.
Tax and Notional Costs of Sale
In order to negotiate effectively, we would need to understand the net value of the business. This would most likely require an accountant to calculate the latent tax liability, which would then be deducted from the value of the business. We would also need to deduct the notional costs of sale, in order to ascertain what you would end up with ‘in your hand’ were the business to be sold.
Options for Settlement
There will no doubt be other discussions and calculations before a settlement can be achieved – for example, to cover the issues of non-matrimonial property and financial “need”, which is pivotal to the issue of fairness. Separate from the issue of fairness, there are further practical considerations before deciding what should happen to the business, including:
- Liquidity – if necessary, can you afford to extract large sums of money from the business (by declaring a dividend or otherwise), in order to buy out your spouse or civil partner. If the business is highly leveraged and/or has minimal cash reserves, this may not be possible.
- Taxation issues – the tax liability payable is likely to vary depending on the structure of the settlement, so it will be necessary to take accountancy advice on the different options available to you and the business.
The appropriateness of the various options is dependent upon the specific circumstances of each couple, including the nature of the business, each party’s involvement with the business and alternative earning capacity, the nature of your relationship with your spouse or civil partner, the number of shareholders, and the availability of other (matrimonial) assets. Options to consider include:
Both remain shareholders
The Court is generally very reluctant for spouses or civil partners to remain tied up in a company together, however in some limited circumstances it is possible for this to succeed. It could be particularly relevant if both of you are heavily involved with the business which has been built up together equally, you have limited options in terms of alternative forms of employment, and you have a good working relationship. In such circumstances, we would strongly advise that you have a detailed shareholders agreement which regulates how the company is to be run, to minimise conflict down the line. Our experienced Corporate Team can work with you in order to ensure the greatest level of security for the shareholders and for the company.
Share transfer
If it is decided that only one of you should remain a shareholder, it is possible that the exiting spouse’s shares can be transferred to the remaining spouse. If this is to take place, however, there should be sufficient matrimonial assets to ensure that the exiting spouse is compensated for relinquishing their interest in the company.
Buyback
In some circumstances, it is possible for the company to buy back the exiting spouse’s shares in the company. Input from accountants is again imperative, as they will be able to advise as to the viability of this option. If there are additional shareholders, their input is likely to be required to authorise the buyback, not least because the overall share structure of the company is likely to change as a result.
Conclusion
Dealing with a business following the breakdown of a marriage or civil partnership is complex and should be done in accordance with expert accountancy advice and legal advice. Here, we have set out some of the issues to be considered, but this is by no means an exhaustive list, and there will be factors specific to you, your marriage/civil partnership, and your business, which will need to be taken into account.
Our team has acted for the owners of all manner of businesses and therefore has the expertise and experience to assist you and your business, either while happily married (in the case of a pre-nuptial or post-nuptial agreement), or upon the breakdown of your marriage or civil partnership.