Dividing a business or professional practice at separation

For a lot of families the business is not just an asset. It is the income, the identity, the retirement plan and the thing that took twenty years to build. That is exactly why it becomes the hardest part of a separation. One spouse fears losing it, the other fears being shortchanged, and neither can look at the number calmly. Both fears are understandable. This guide is about setting the emotion aside long enough to get the mechanics right, because the mechanics decide the outcome.

Is the business divisible?

Canada

A business interest acquired or grown during the relationship is generally shared. In Ontario, its value goes into the owner's net family property for equalization: the business is not carved up, but its value is counted, less any value it had on the date of marriage. In BC, a business owned before the relationship is excluded property, but growth in its value during the relationship is family property. Other provinces have their own versions of these rules, and in some, common-law partners are treated differently from married spouses. Check your provincial hub.

United States

In community property states, a business started during the marriage is generally community property. In equitable distribution states it is marital property, divided in a way the court considers fair, which is often but not always equal. Where a business was owned before the marriage, many states share some or all of the growth during the marriage, and some distinguish growth caused by a spouse's work from growth caused by the market. State rules differ a lot here.

Two common complications

If the business existed before the marriage or relationship, its value at that start date matters, so it is worth establishing early. And if there are other shareholders or partners, a shareholder or partnership agreement may restrict transfers or require a buyout at a set formula, which shapes how the non-owner can be paid.

How is a business valued at separation?

You will need a professional valuation unless the business is very small or you both agree on a number. In Canada, look for a Chartered Business Valuator (CBV). In the US, common credentials include Accredited in Business Valuation (ABV), Accredited Senior Appraiser (ASA) and Certified Valuation Analyst (CVA). Valuators use three broad approaches:

• Asset-based. What the assets are worth minus the liabilities. Common for holding companies and businesses with little goodwill.
• Income-based. Capitalising or discounting the business's expected cash flow. Common for established operating businesses.
• Market-based. What comparable businesses have sold for. Useful where good data exists.

Expect the valuator to normalise the financial statements: adding back personal expenses run through the company, adjusting the owner's pay to a market rate, and removing one-off items. This is where most disputes live, because "normal" involves judgment.

Personal versus commercial goodwill

A dental practice or a consultancy may be worth a lot to its owner and much less to anyone else, because the clients follow the person. Many jurisdictions treat personal goodwill, which depends on the owner, differently from commercial or enterprise goodwill, which would transfer to a buyer. The rules vary: some US states, including California, can treat goodwill in a professional practice as divisible. Ask your lawyer how your jurisdiction handles it, because it can change the number dramatically.

Cost

Valuation fees depend on the size and complexity of the business and the level of report you need. A joint valuation, where you both retain one neutral valuator, usually costs much less than two opposing experts and often produces a number both of you can accept. Ask for a scoped quote in writing.

What is double dipping?

Here is the trap. A business valued on its future income is shared as property. Then support is calculated on the owner's income from the same business. The non-owner can end up compensated twice from the same dollars, and the owner pays twice.

Courts in both countries are alert to this, but there is no single rule. In Canada, the Supreme Court's decision in Boston v. Boston addressed double recovery in the context of a pension already divided as property, and the same concern is often argued for businesses and other income-producing assets. Some US courts make similar adjustments; others do not. The practical lesson: negotiate property and support together, not in separate rooms, and make sure whoever values the business and whoever calculates support are working from consistent assumptions.

Business income for support is its own topic. In Canada, the Federal Child Support Guidelines allow some pre-tax corporate income to be counted as the owner's income in certain circumstances. Read how support is calculated for self-employed people.

How do couples usually settle a business at separation?

Couples settle a business in one of three ways: the owner keeps it and offsets its value against other assets, the owner pays out the other spouse's share over time, or both keep an interest in it. The first is by far the most common.

1. Offset against other assets

The most common outcome. The owner keeps the business; the other spouse takes a larger share of the house, the investments or the pension. Clean, final and often tax-efficient. It only works when there are enough other assets to balance against.

2. Structured payment

The owner pays the other spouse's share over time, from the business's cash flow, with interest and security. Common when the business is the main asset. Document it properly: payment schedule, interest rate, what happens on default, what happens if the business is sold, and security such as a pledge of the shares or a personal guarantee.

3. Continued co-ownership

Rarely wise, occasionally unavoidable. Both keep shares and the spouse who is not running the business receives dividends or distributions. It needs a proper shareholder agreement with exit rights and a level of trust most separating couples do not have. Treat it as a bridge to a buyout rather than a destination.

Tax

Transfers of shares between spouses on separation can usually be made on a tax-deferred basis: in Canada under the spousal rollover rules, and in the US under Section 1041 of the Internal Revenue Code. Payments made over time may include taxable interest. Selling the business, or having the company buy back shares, to fund a payout can trigger tax. Get tax advice before you settle on a structure, not after. Our guides to separation and tax in Canada and US tax implications of divorce cover the basics.

Protecting the business during the process

Both of you have an interest in the business not being damaged by the separation. Practical measures:

• Agree in writing that the owner will keep running the business in the ordinary course.
• Agree that no unusual transactions, such as large purchases, loans, new shareholders or changes to pay, will happen without notice.
• Agree to share monthly or quarterly financial statements until the matter is settled.
• If the spouse who is not the owner works in the business, agree how their role and pay will continue or end.
• Keep the separation away from staff, clients and lenders as far as possible.

If you suspect the owner is depressing the value, read the warning signs of hidden assets.

What to gather

• Three to five years of corporate financial statements and tax returns
• General ledger or accounting exports for the last two years
• Shareholder, partnership and buy-sell agreements
• The owner's personal tax returns for the same period
• Any earlier valuations, offers to purchase, or loan applications that stated a value
• Records of the business's value or financial position at the date of marriage, if it existed then

The financial disclosure checklist covers the rest of what you will need.

What to do this week

1. Find the shareholder or partnership agreement and read the transfer and buyout sections.
2. Collect the last three years of financial statements and tax returns for the business.
3. Write down the date the business started and anything you know about its value at the start of the relationship.
4. Agree in writing how the business will be run while you negotiate.
5. Ask two valuators for a scoped quote, and raise the idea of a joint valuation with your spouse.

Common questions

Do we both need our own valuator?

Not usually. A jointly retained neutral valuator is cheaper and often more credible. Each of you can still have a lawyer or accountant review the report.

My spouse says the business is worthless. Is that possible?

Sometimes, especially for professional practices that depend on the owner or businesses carrying real debt. But a claim that a business is worthless deserves a valuation, particularly if it supports a comfortable lifestyle.

Can my spouse force a sale of my business?

Courts generally avoid ordering the sale of an operating business. The far more common result is that the owner keeps it and compensates the other spouse through other assets or payments over time.

Does a prenup or cohabitation agreement protect a business?

It can, if it was properly drafted with full disclosure and independent legal advice for both people. See the prenuptial agreement guide for what makes these agreements hold up.

I worked in the business but I am not a shareholder. Do I have a claim?

Often, yes. The value of the business can still be shared as family or marital property even if only one of you holds the shares, and unpaid work in the business can be relevant to both property and support. Get legal advice on your specific situation.

This guide is legal information, not legal advice, and it is written for a general audience across Canada and the United States. Family law is provincial and state-based and changes over time. Before you rely on anything here for your own situation, confirm it with a qualified family lawyer in your province or state. FairWell can connect you with one through the professional directory. How we write and check our guides.