In a divorce, who gets what?
As demanding as the process of divorce can be, it becomes even more complex when a family business is involved.
Few divorce settlements rival the 4% stake in Amazon, valued at $38 billion, that MacKenzie Scott received in her split from husband Jeff Bezos. It recognized her contributions to the company’s growth by awarding her a quarter of the shares held by the couple. Even though your business may be worth considerably less than Amazon, and even if all the couples in your family are getting along well, you should take steps to protect the assets from a divorce.
Integrated business and personal plans
Your family enterprise should have a formal business plan that is well integrated with family members’ personal financial plans. In order to develop these plans in concert and protect the vitality of the business while equitably addressing the needs of the people involved, you must carefully consider the interests of controlling and successor-generation members.
Why are integrated business and personal plans so important? Perhaps a surviving spouse will need to live off distributions from the family business. Arranging a trust and estate plan to monetize company stock can provide the spouse with lifetime income. Perhaps a family member may have to liquidate stock to fund an estate plan or a divorce. Failure to allow for such a situation can leave the business with insufficient liquidity, placing a strain on the business plan.
Integrated plans also can help prevent problems that could arise if company shares end up in the hands of an ex-spouse (in the event of a divorce) or a non-family member (perhaps through an inheritance). In such cases, business leaders could find themselves negotiating with a major shareholder who is acting in bad faith.
An effective shareholder agreement is essential. The agreement might stipulate, for example that non-family members cannot own company stock. (If so, the family should create a policy that defines “family members” and “non-family members”). A shareholder agreement should state how surviving married-ins would be bought out in the event of a shareholder’s death.
It all boils down to keeping lines of communication open and ensuring all interested parties remain clear on the business and estate plans. This is a process that ideally should begin before a wedding occurs. Here are some things to consider when undertaking that planning, and dealing with its evolution should divorce become an unfortunate reality.
The value of a good prenup
It’s no surprise that prenuptial agreements are one of the most powerful tools available for establishing ground rules and minimizing business-related disputes if divorce occurs. The guidance of a lawyer specializing in this area is indispensable.
An effective prenuptial process provides three layers of protection to ensure the family will retain control of its business. First, an ownership interest in a family business can be titled as separate property. Second, the prenuptial agreement can reinforce this by treating family business shares as separate property rather than a marital asset. This matters because growth in value of family business shares is usually treated as a marital asset. An irrevocable trust also can be created to own shares of the company as part of this step. Third, a well-drafted shareholder agreement can specify who may be allowed to own stock in the company. For example, Katharine Graham, legendary publisher of the Washington Post, inherited control over the paper upon her husband’s death because she was allowed to become a shareholder.
An agreeable shareholder agreement
The policy governing who may own stock in the family business must be established by family consensus. For example, can married-ins, stepchildren or unmarried partners become shareholders? In case of a family member’s death, will the company buy out the shares of a non-family inheritor? This is an opportunity to protect the business, as well as the interests of family members. The only “right” answers are those on which family members agree.
For the policy to be enforceable, it must become legally binding by inclusion in a formal shareholder agreement. If that agreement is well constructed, it should be reviewed and possibly amended in every generation; a poorly written agreement will need amending before any major event, such as a business ownership change, marriage or divorce.
Advantages of an irrevocable trust
As previously mentioned, an irrevocable trust can provide a second layer of protection in addition to a prenuptial agreement—protection a revocable trust cannot provide because its assets are still in the Grantor’s name. Having the trust own the family business shares ensures the shareholder and spouse don’t have an ownership interest. It provides protection against creditors. And, because the family is the beneficiary of the trust, it maintains control of the business if a family member’s marriage dissolves. Yet an irrevocable trust still allows sale of the trust’s shares of the business if all family members agree to it.
In a divorce, who gets what?
When Jeff Bezos and MacKenzie Scott divorced, she agreed that he would retain voting control over her Amazon shares and maintain his interests in the Washington Post news operation and the Blue Origin aerospace venture.
The key to managing a division of assets is understanding all the assets that are owned and their monetary value, as well as what the assets mean to each party. One partner in the split may value keeping control of the business interests, while the other may care about the primary home and the charitable endeavors, as in the Bezos/Scott divorce. The divorce settlement may be equalized in other areas, too, by using assets such as vacation homes and land. Those who have additional private equity interests outside the family business will want to consider their treatment as well.
You’ll also want to understand the long-term implications on the business and on the children, especially since the possibility of subsequent marriages (and future children) must be factored into the equation.
Building equity for the future
Of course, the interests of younger family members are also a key consideration in any restructuring related to changes in marital status.
In the third generation and beyond, it’s common to see more passive ownership in the equity structure. Shareholders who don’t work in the business may not know how business and estate plans are integrated. They also may not recognize potential risks to the enterprise or to the financial benefits they receive from it. Getting the time and attention of all stakeholders so the risks can be defined and appropriate planning can occur might be the biggest challenge of all.
Having a well-constructed yet flexible shareholder agreement in place will help lay the groundwork for any additional children brought into the family through remarriage. The shareholder agreement sets the rules for engagement so you can navigate these situations with clarity.
Planning for succession
Presuming that the controlling generation has addressed matters such as business continuity planning, disaster planning and estate planning, as the succeeding generation is groomed to take control, it’s imperative to integrate both generations’ estate documents and the business entity structure.
The documents must be flexible in anticipation of potential future divorces, remarriages and stepchildren entering the picture. Estate and succession plans must be put in writing and clearly communicated. Family values and policies must be developed to help family members manage change. Advance planning can help mitigate conflict when relationships are strained.
As the family and the business grow and change, asset-protection strategies should evolve. They may include a change in titling or creation of news trusts; rewriting shareholder agreements to define who may and may not own shares; ensuring business and family financial plans address liquidity in the event of divorce or death; providing for the business to raise cash by selling shares to family members, to private equity or to an outside buyer; or providing for the possibility of a shareholder loan.
As the years go by, family and business situations change. There’s no substitute for advance preparation. FB
Jon Moore is regional director and partner at EP Wealth Advisors (epwealth.com).