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 cheated out of it, and neither can look at the number without emotion. This guide is about taking the emotion out for long enough to get the mechanics right.

Is the business divisible?

In Canada, a business interest acquired or grown during the marriage is generally family property. In Ontario its value goes into net family property for equalization; the business itself is not carved up, but the owner accounts for its value. In BC and most other provinces the growth in value during the relationship is what is shared. In US community property states, a business started or grown during the marriage is community property to the extent of that growth. In equitable distribution states it is marital property subject to a fair division, which is usually but not always equal.

Two common complications. If the business predates the marriage, only the increase in value during the marriage is typically shared, which makes the value at the date of marriage a number worth establishing. And if there are other shareholders or partners, a shareholder agreement may restrict transfers, which shapes how the non-owner can be paid out.

How a business is valued

You will need a professional valuation unless the business is tiny or you both agree on a number. Chartered Business Valuators in Canada and Accredited Business Valuators in the US 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 financials: adding back personal expenses run through the company, adjusting the owner's salary to market, and stripping out one-off items. This is where most disputes live, because "normal" is a judgment call.

Personal versus commercial goodwill

A dental practice or a consultancy may be worth a lot to its owner and almost nothing to anyone else, because the clients follow the person. Many jurisdictions distinguish personal goodwill, which is not divisible, from commercial goodwill, which is. Professional practices often carry lower divisible values than their revenue suggests.

Cost

Valuations range from a few thousand dollars for a simple business to tens of thousands for complex ones. A joint valuation, where both spouses retain one neutral valuator, is far cheaper than duelling experts and often produces a number both sides can accept.

The double-dipping problem

Here is the trap. The business is valued on its future income. The owner pays the other spouse for their share of that value. Then spousal support is calculated on the owner's income from the same business. The non-owner is paid twice from the same dollars. Courts in Canada, following the Supreme Court's decision in Boston v. Boston, and in many US states try to avoid this, but the rules are not uniform. Whoever owns the business should raise it early, and whoever doesn't should understand that the support number and the property number are connected.

The three ways couples settle it

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 usually 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. This is common when the business is the main asset. Get it documented properly: payment schedule, interest rate, what happens on default, what happens if the business is sold, and security such as a charge on the shares or a personal guarantee.

3. Continued co-ownership

Rarely wise, occasionally unavoidable. Both keep shares and the non-operating spouse receives dividends. It requires a proper shareholder agreement with exit rights, and a level of ongoing trust that most separating couples do not have. Consider it a temporary bridge to a buyout rather than a destination.

Tax

Transfers of shares between spouses on separation can usually be done 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 over time may have interest components that are taxable. Selling the business to fund a payout triggers capital gains. Get tax advice before you settle on a structure, not after.

Protecting the business during the process

Both spouses have an interest in the business not being damaged by the separation. Practical measures: agree in writing that the owner will continue to run it in the ordinary course, that no unusual transactions will occur without notice, and that financial information will be shared monthly. If you suspect the owner is depressing 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 and partnership agreements
• Owner's personal tax returns for the same period
• Any prior valuations, offers to purchase, or financing applications that stated a value

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.