Episode 132 - How to Divide A Business in a Divorce
Dividing up a business inside of a divorce creates its own set of challenges apart from the divorce. If the business is a small to medium sized family business, it can be like having two divorces at the same time. Fortunately, there are ways to work through the challenges to reach a fair and equitable resolution. In this show, Leh and Todd discuss a variety of ways to divide up a business in a divorce. They give an overview of how businesses are valued by experts. They conclude with several creative options to handle a 'business divorce' that they have seen work for certain specific business and couples.
Leh Meriwether: Welcome, everyone. I'm Leh Meriwether. With me is Todd Orston. Todd and I are partners at the law firm of Meriwether and Tharp, and you're listening to the Meriwether and Tharp Show. Here, you'll learn about divorce, family law, tips on how to save your marriage if it's in the middle of a crisis, and from time to time, even tips on how to take your marriage to the next level. If you want to read more about us, you can always check us out online, atlantadivorceteam.com.
Leh Meriwether: Well, last week, you know, what I love about this show is we can shift massive directions like which way we're going. Last week, we talked with Matt Driggers about a type of counseling that I'd never heard of before. You haven't heard of it before either. Discernment therapy, which is a great alternative to marriage counseling because sometimes marriage counseling is just a waste of time and money, whereas discernment therapy could potentially save a marriage or make the divorce a lot less painful, so if you're curious about what that is, you definitely want to listen to the last show. You can find that at divorceteamradio.com.
Leh Meriwether: But today, big time shifting gears.
Todd Orston: Absolutely.
Leh Meriwether: We are shifting from discernment therapy to how do you deal with a business in a divorce? What happened, recently I actually did a seminar, it was a national seminar. Well, we call it CLEs, for Continuing Legal Education, and that's where we as lawyers have to, to maintain our bar license we have to attend seminars. They're called Continuing Legal Education seminars, and this one I was actually presenting at. It was a national one dealing with how do you handle a business in a divorce. Sometimes the question, depending on the type of business, it can be very, very serious.
Leh Meriwether: I mean, I think the biggest one we've ever seen was Amazon, Jeff Bezos. We had a whole show about that and how he was a majority shareholder in it. That was the majority of their assets, and how with Mackenzie, that was her name, right, that's his wife's name, Mackenzie, how would they split all that up. How would you deal with it? As I understand it, she actually had a I think she got, what, $38 billion, so she didn't even get half, but how do you survive?
Todd Orston: I mean, I just don't understand.
Leh Meriwether: She got a very small, as I understand it, a small portion of the stock so it didn't create an issue. I think he's still the majority shareholder. Sounds like they worked out something that they felt was fair.
Todd Orston: And we understand. Not everyone listening owns an Amazon-like business, but a lot of the concepts are going to be the same, and there there were a lot of things that had to be considered, because in a perfect world we could take all the assets and just divide it right down the middle. We could say 50/50 and we'll figure out what that looks like, but everybody walks away with the exact same thing or the exact same amount. But when you're dealing with a business, like when he was dealing with Amazon, that's no possible. By doing that there are absolutely immediate consequences on ownership interest in that business, which then deals with issues of control, and so splitting 50/50 of that asset just wasn't possible.
Leh Meriwether: Right.
Todd Orston: Then you look at what they actually-
Leh Meriwether: Well, it was possible, but there could have been really negative consequences.
Todd Orston: Exactly, exactly. So basically they were able to work something out. She was I guess treated fairly with 38 billion.
Leh Meriwether: That's my understanding.
Todd Orston: My mouth almost doesn't even make, I can't even say those words. That's alien to me. But they were able to work it out and was it a 50/50? No. Was she still treated very fairly and were things done in a way to maintain his control over the business and maybe that might have translated to some alimony issues or some additional monies that were paid? I don't know. But the bottom line is that it wasn't 50/50 but it was fair. These types of considerations even when you're not dealing with Amazon, you have to consider these things and that's what we do.
Leh Meriwether: So we're going to talk about, because I think Amazon, that is a unique animal.
Todd Orston: Absolutely.
Leh Meriwether: We're not going to be talking about that. We're going to be talking about what we see most common. We see businesses that are making anywhere from $100,000 to millions of dollars, 10, 20, 30, 40 million dollars and up. I think the most common ones you see are making anywhere from $100,000 to $10 million. That's the bulk of them, and there's actually certain plateaus. Certain businesses hit a million and sort of plateau out. Sort of the next as I understand it, $10 million is the next place where businesses can stall and then they grow. But that's where you see the bulk of them, in that range.
Leh Meriwether: So today we're going to talk about, I'm not going to be talking as a lawyer explaining things to other lawyers. I'm going to be talking to the business owner or the person that's married to the business owner. We're going to talk about how to break these, how do we deal with them in a divorce? We've had cases where both couples were very involved in the business, and what would happen if one of them left? Would it cause the business not necessarily to collapse but how integrated were they in the business? I've seen cases where both of them were integrated in the business but the employees only liked one of the owners.
Todd Orston: I've seen that quite often, actually.
Leh Meriwether: But the other one was sort of in charge, the one the employees didn't like, and it wasn't because he was in charge that they didn't like him or her, it was the way they treated the employee.
Todd Orston: Well, I've also seen where they're both involved but let's say it was a service-related company, and the one that the people didn't like as much was really the hands on, day to day providing of services to customers and the other one was the back office, basically kept the office running, kept the business going. So who's more valuable? The one who's going out performing the work with customers or without the person behind the scenes, they would have closed up shop years earlier because they-
Leh Meriwether: They paid the payroll.
Todd Orston: They took care of payroll, they took care of all the bill pay, dealing with vendors and subs and whatever is needed in the business. Again, these are all considerations, so sometimes it's not easy to just surgically remove one party from the business and assume that the business is just going to be able to keep going and be successful.
Leh Meriwether: And just, we're going to touch on using business valuators. I'm not going to go, even though that's what the topic was, how do you value a business, part of the presentation was dealing with stock options, which is another complicated. Some areas that can complicate a divorce, especially if you have a CEO or somebody who's received a substantial amount of stock or stock options. How do you value it, how do you deal with a divorce? We're not getting into that today.
Leh Meriwether: We are going to bring on one of our business valuators that we really like, because he does such a great job. His name is Seth Murphy, and the reason we like him is because he's not a hired gun. Some people will say, "How much do you think the business should be worth?" And they'll see if they can get it there. Seth is like, "Here's my honest opinion what it's worth, here's what I'm willing to testify in court what it's worth." He's really upfront with you, so we like him for that reason. His math and approach is sound.
Leh Meriwether: But we're going to touch on what evaluators do and then we'll save the deeper dive for when he comes on the show. The first thing I wanted to touch on is the different types of valuations that can be done. Sometimes as a certified business valuator, one of the things that he can do is do what's called a calculation of value. There's two types of opinions that that can present, a calculation of value and a business valuation. The calculation of value, it's a much simpler one. It's the least expensive one, but at the same time it's not one that he likes to testify in court about. The business valuation one is... I don't want to say... They're both legitimate, but the business valuation is much more detailed, it's supported by more data.
Todd Orston: Yeah, it's a quick and dirty valuation process to try and get parties to a point where maybe they can reach an agreement as to numbers, and usually that's going to be a better option or just an option. Where the parties are working amicable towards a resolution, meaning you're not getting, there's not huge hangups on the property valuation and things like that, but they need a working number that they can both agree on because the alternative is, like you said, much more complex, much more in depth, and much more expensive.
Leh Meriwether: More expensive. Yeah. That's a great point. With the calculation of value, you can have two very reasonable people. They've made the decision, we're getting a divorce, and they say, because they're reasonable, they don't want to argue about the business valuation. They're like, "You know what, can we have a third party just give us a rough number, and if it sounds good, we'll just both accept it and then work from there." Going back to the whole thing, if they're saying, "We're trying to be fair to each other," the calculation of value is a great option there because it's a rough, I think one time he said the back of the napkin approach. He gives a rough number.
Todd Orston: Based on analysis.
Leh Meriwether: Based on analysis. It's just not a super deep analysis.
Todd Orston: It's not a deep dive.
Leh Meriwether: Yeah. And often that's all that's needed, and it's very helpful to them. We're going to talk about that. We're going to talk about what's involved with the business valuation. We're going to talk about the different valuation approaches, because there's three different approaches that business valuators use in coming up with an overall value of the business. We're going to talk about that and then we're going to spend a large portion of the show talking about, okay, now that we have a value, how do we divide this up? What options are available to the business owners in the divorce so their business doesn't go under after the divorce?
Leh Meriwether: Welcome, everyone. I'm Leh Meriwether and with me is Todd Orston. Todd and I are partners at the law firm of Meriwether and Tharp and you're listening to the Meriwether and Tharp Show. If you want to read more about us, you can always check us out online at atlantadivorceteam.com.
Leh Meriwether: Well, today we're talking about business valuations. How do you deal with a business when the parties are going through a divorce, because we do encounter those frequently, and usually it's not an Amazon situation like when Jeff Bezos got a divorce. Most commonly we see businesses that are earning anywhere from $100,000 to $10 million a year. I mean, we've dealt with some that earn a lot more than that, but general speaking that's the most frequent that you see.
Todd Orston: And look, the interesting thing with businesses as with... The application of fuzzy math, meaning you could talk to one attorney or one person and they could put a value of something, of a dollar on a business, say, "Well, it really doesn't have a lot of value." Yet you calculate the value in a different way and it's worth $100,000. Those numbers can be depending on the type of company, it could be, "Oh, the company's only worth a million dollars," but you crunch the numbers a different way and it's like, "That's a $15 million company." Then again we get into some of the issues we were talking about before, where, "Okay, but I can't," if most of the value is tied into the business, like let's say a construction company. That's great. We add up all of the assets and I have dump trucks and bucket loaders and I have all this other equipment. Great, it's worth $5 million. I want two and a half million dollars. Okay, so that means I have to sell all of this equipment and then I can't do the work, and basically the business is gone.
Leh Meriwether: Right.
Todd Orston: So there is so many considerations that you need to, again, take into consideration. You need to think about these things, and that's why it does get complicated and why usually we want to bring somebody like Seth in to help us to approach it and maybe look at it in different ways to help parties understand what the value truly is.
Leh Meriwether: Yeah, and there's three approaches when you do a true business valuation. That's one of the opinions a business valuator can give. They take three approaches, and then from those three approaches usually they yield three different numbers, two of which are very similar but the other one's often the lowest. That's the asset approach. The three approaches are asset approach, income approach, and market approach. Often, the income approach is close to the market approach, with some exceptions, but the asset approach is typically the lowest. What's important here, you'll see this sometimes, people will come in and go, they'll have their tax return and say, "Well, my business isn't worth anything." Well, and perhaps it's a dentist office that it's like a year old, and they spent several hundred thousand, maybe $500,000 buying all this equipment, the nice chairs, all this, and they for whatever reason under IRS guidelines, they were able to depreciate all of it in the first year. I'm not saying that could happen, but you never know when the tax laws are constantly changing. So the book value of the business could have been at zero, because the book value is the value on the tax return. That's what they dropped it at.
Leh Meriwether: But from a standpoint of an asset approach, that's not the true value. The asset approach is what's the fair market value of that equipment? I mean, they may be able to sell it for a quarter of a million dollars, so perhaps he hasn't started earning any money with this business.
Todd Orston: And that doesn't work also with a lot of service-related companies. When you have a solo practitioner or an attorney or you have a CPA or someone where it's really very heavily based on services, and the equipment that they have is maybe a computer and a chair and a desk. Okay, so my business is worth $24.22. But if they're doing a whole bunch of business and if they are working in a way that basically they have a lot of income or they have the ability to pass that business on to someone else in some form or fashion, then clearly it's worth more than $24.00.
Leh Meriwether: Right. In that situation you would look at the income approach and the market approach, because they'd have a far greater value there than the asset approach. That's why you can't look at any one specific approach and say, "Okay, that's the value," because it's so dramatically different. Now, probably a good point to say, the market approach is often close to what that calculation of value is. In fact, many of the business valuators I know, they have rules of thumb, and when I say rules of thumb, they have access to sort of industry standards. Seth actually shared some of his with us one time.
Leh Meriwether: For instance, an autobody repair shop. When you look at the industry standard, it's 25-35% of their gross annual sales. And a bakery, 40-45% of their gross annual sales. An accounting or tax practice, 100-135%. So he takes some information, applies some of it to the rule of thumb, and comes up with the calculation of value, not the true deep business value.
Todd Orston: The analogy would be sort of like with real property valuations. You'll go and you'll have your house valued, and there are comps. When you look in the valuation report, basically the appraisal, you're going to see some comps. Two, three, four five comps. And that's what we're talking about. It is, "This is what other similar homes have sold for in your area and therefore that's going to form at least a part of the basis for the valuation of your home."
Leh Meriwether: I'm glad you brought up that analogy because-
Todd Orston: You're welcome.
Leh Meriwether: ... because that's probably a good way to break down the differences between with the calculation of value versus the business valuation. The calculation of value is like going to a real estate agent and having a comparative market analysis. They're just looking at the comps, but the real estate appraiser's going to go inside the home, see its condition. I mean, there could be things falling apart, and because of that, yeah, the comps pull it up, but then because all these repairs need to be done it drops the price. So that's a good way to compare the calculation of value versus the business valuation.
Leh Meriwether: All right. So let's talk about sometimes that market approach doesn't work. Perhaps the bakery, it's got a million dollars in sales. So you apply the 40%, it's worth $400,000. Well, not exactly, because I have $800,000 in debt. Well, that will offset that valuation. The debt will offset the valuation, so you can't just look at the market approach. All these factors come into play and it's really fascinating.
Leh Meriwether: Looking at the income approach, here's a good example. Let's say you got a business and this business has a net income, so after the business has paid everybody, it brings in $120,000 or to the shareholder, the sole shareholder receives $120,000 in net profit, and the sole shareholder's also an employee in the company but only gets paid $5000. Well, if you've got, let's say it's an auto body shop or a mechanic shop. Not an autobody shop but a mechanic shop. And the mechanic or the owner happens to live in Florida but the shop is up here in Georgia. Well, he's really not doing anything. Maybe he's doing a little bit of marketing or managing the books and everything, so he pays himself a "salary" of five grand. Well, if he's barely doing anything and he's bringing in $120,000, under the income approach that business is very profitable. It has a high value because he has to do very little for it to operate.
Leh Meriwether: But if you take, let's take going back to-
Todd Orston: Owner operator.
Leh Meriwether: Yeah, the owner-operator. So he's barely doing anything but he's really got a manager in there who's managing the day to day operations.
Todd Orston: But the alternative is that you're going to get to is the person who is the owner operator, the one who's actually on the ground doing the work and pulling the salary.
Leh Meriwether: So let's use, I'm going to change it now. Let's say it's a consulting business, and let's say in this consulting business there was the woman that owns it, she prior to starting this consulting business, she actually worked for let's say Deloitte or some big consulting-type company, and she got paid $300,000 a year when she was there, and now she's working this business. She's been in it for a few years. She is busting her butt. She's working 80 hours a week. She's only paid herself a "salary" of five grand but she still had profits of 120, but when you add those two together you're looking at $125,000, which is a far cry from the 300,000 she was earning. In that situation, that business really isn't worth anything because the valuator's going to go in there and say, "Okay, if I had to replace the business operator, if I had to pull her out, maybe I wouldn't pay her replacement $300,000 because this consulting company doesn't have the name of, like I said, Deloitte or something like that, doesn't have that name, so she wouldn't earn $300,000, but $200,000." Well, now under the income approach this business is upside down $75,000. Hopefully I didn't get too technical there. Trying not to.
Todd Orston: You can hope. No harm in hoping.
Leh Meriwether: But the reason, I know I did go probably a little too deep there, but the point was to give an example of how deep the lawyers can get with the help of a business valuator. Because somebody may say, "My business is worth nothing," and they may be right, or they're just saying that because they don't want to pay their spouse anything. Up next we're going to talk, we're going to continue to dive into how do you actually, once you figure out a value, how do you fairly split it up?
Leh Meriwether: Welcome, everyone. I'm Leh Meriwether and with me is Todd Orston. Todd and I are partners at the law firm of Meriwether and Tharp and you're listening to the Meriwether and Tharp show. If you want to read more about us, you can always check us out online, atlantadivorceteam.com.
Leh Meriwether: Today we've been getting into business valuations, and I'm trying not to go too deep. The problem is in my head I just recently finished presenting at a seminar to other lawyers about how do you deal with valuing a business inside the context of a divorce, and then what do you do with it once you've given it a value. How do you give the other spouse, perhaps you've got one that owns the business and the other one that doesn't, how do you fairly pay that other person without potentially causing the business to collapse?
Leh Meriwether: But before we get into that, how do we break up this, how do we deal with that fairness aspect, we still wanted to cover a few more things with the valuation, because I'm sure a lot of people have got questions.
Todd Orston: I'm sure. I have questions.
Leh Meriwether: Oh, what are your questions?
Todd Orston: Inquiring minds want to know.
Leh Meriwether: You must have missed my seminar.
Todd Orston: Yes, I did actually, and I'm sure it was fantastic. But let's talk about, we're scratching the surface. For anybody and everybody listening, understand that it would be almost impossible for us to do a full lesson on business valuations and do a deep dive in terms of teaching all the ins and outs of business valuations. But there are terms that anybody who is potentially thinking about a divorce or thinking about anything where a business valuation is going to be an issue, there are things you need to be aware of. There are terms and what have you that you need to recognize, things like goodwill or discounts, valuation discounts that need to be or can be considered. Let's jump into some of those. Let's talk about those because I know you spent some time at the seminar teaching on that. When I use words like goodwill or valuation discounts, what am I talking about?
Leh Meriwether: Let's hit goodwill first. You've got goodwill, and that's really the difference between the asset approach and the income and market approach. It's that sort of intangible asset. Your assets are worth $100,000, but you're selling $5 million worth of goods every year, so the difference is goodwill, meaning what is the value of this business to the customers? So that's the goodwill. Then within that goodwill, there's two different types of goodwill. There's personal goodwill and enterprise goodwill.
Leh Meriwether: Enterprise really is associated with the business. In Georgia and Florida, the courts really only look at enterprise goodwill. Personal goodwill is considered separate proper to the person. A good example of personal goodwill might be a solo practice. When I say solo practice, you've got a lawyer and it's just the lawyer and a paralegal, and they have perhaps a divorce practice. Well, that entire divorce practice is dependent on that lawyer and their personal goodwill and it's really hard to put someone else in that place and take over. It's difficult. So there's a high level of personal goodwill associated with that business. It might have a tremendous amount of income, but if it's all associated with the lawyer or 90% of it, there's going to be a 90% discount on the value of the business. You take all these approaches, and you say, "Under these approaches, it has a value, this business, this law practice, has a value of $500,000." Then you have to multiple that times 10%, which would drop it down to $50,000, and that's the value of the business for the consideration of the divorce.
Todd Orston: Yeah, and again, in a divorce we're going to be talking about, there are a number of issues. We're talking about property division. That doesn't change the fact that for purposes of child support calculation, alimony calculation, if that person is making $500,000 a year, that person's making $500,000 a year. We're talking about how does the asset, the business, get divided, and what value is being attributed to that asset?
Leh Meriwether: Yeah. With most of those law practices, there's some exceptions, but most of those law practices, the personal goodwill is 99%.
Todd Orston: Right, but as opposed to, and I know this is where you were going to go, as opposed to let's say a firm like ours. Okay, where the name has become something more than just a single person. We are a bigger firm and therefore arguably someone else could step in and become sort of enmeshed in the company and then take over the firm, and Meriwether and Tharp is still Meriwether and Tharp. So even if you stepped out, Bob stepped out, Bob Tharp, please don't. No, but the point is, you could step out and it would still be Meriwether and Tharp, and the company itself, the firm has value.
Leh Meriwether: And some of the other law firms, like King & Spalding is probably another good example.
Todd Orston: That's right.
Leh Meriwether: They do corporate law and I think they represent the top 50 businesses in the the-
Todd Orston: It's much bigger than the two names.
Leh Meriwether: And they've been dead for a while, the King and the Spalding.
Todd Orston: Which I hear they're great in court now. Sorry, that was terrible. Anyway, the point is well-taken, that it is King & Spalding, but it's not all about, of course, King and Spalding.
Leh Meriwether: Right, that's the name now.
Todd Orston: It is now a business and the enterprise itself has value.
Leh Meriwether: Yes. So the same thing will apply to a lot of businesses. Use Dave Ramsey, for instance. Dave Ramsey Solutions, it does sound like there would being a lot of personal goodwill in that because he did start it. It was associated all with his name.
Todd Orston: And there is an aspect of personal goodwill.
Leh Meriwether: Of course, but he has now set up his business so that if he passes away, that business will keep operating. Zig Ziglar is another example. His businesses continue to operate even though he's been dead for several years. People tend to make too much, there's a tendency to make too much issue about personal goodwill. I don't want to get people too tied up, "Oh, the business, it's just me. You take me out of the picture, it's gone." That's where the business valuator comes in.
Todd Orston: All right, so let's now talk about what are valuation discounts?
Leh Meriwether: All right, so a lot of times you have a minority owner. Well, if it's a minority owner in Coca Cola, you can sell your shares and it's no big deal, but when you have a non-publicly traded small business, the minority owner, well, that means they have a lack of control in that situation. They can't easily sell it because that's a lack of marketability. So there's two discounts really that play into this. It's the lack of control because they're a minority owner, and typically there's discounts have given 15-30% there. So this says, all right, your business, let's say you own 10% of a bakery and we valued that bakery as a whole at $400,000. If both business owners went out and sold it tomorrow, the smaller owner would get, the 10% owner would get $40,000. Well, but if they're not doing that, because in the context of a divorce they're not doing that, you can't just say, "Well, that small business owner, well, okay, it's 40 grand is its value and we're going to split that 50/50." No, because you have to give them a minority discount.
Todd Orston: And think of it this way. It's going to be less appealing to a potential purchase who is going to come into a bakery and say instead of, "Oh, I will buy the bakery and now I control the bakery," you are able to sell let's say 10%. The market is much smaller for somebody who is willing to, even if that opportunity exists, to step into that business only to purchase 10% of the business. I'm not saying it can't happen, but the market itself is much smaller. There are fewer people that want to do it, thus the discount.
Leh Meriwether: With that particular discount, you can actually stack those discounts. On the lack of control, the minority interest discount, let's say we put it at 30%. But then we say, "There's a lack of marketability for this particular business and we're going to put that at 20%," because it's between 20 and 25%. Now all of a sudden you have a 50% discount, so the marital interest in this business is $20,000, of which if you were to split that 50/50, then the husband, let's say the husband owned the 10%, he was a baker, he only needs to pay her if we're going to just do a cashout option, $10,000 out of the business and we've split it. So that's where something, a business on the surface could look very valuable. In fact, we've had people come in and say, "It's making a million dollars. It must be worth $5 million." Well, no. Sometimes we start with a rule of thumb. Well, if I look at the rule of thumb it's only 40% of gross sales, so at best it's worth 400,000.
Todd Orston: Then there are marketability issues. There are discounts that have to apply. And keep in mind, there are arguments against anything and everything, of course, but if you're going into court and there's an expert on the other side who is doing this analysis and it is accepted analysis for a business valuation, you're fighting an uphill battle. So you just need to be aware of the terms that are going to apply and the analysis that would be done and used in the context of a case.
Leh Meriwether: And I really am trying to do my best to keep this as simple as possible, but it still can get complicated. We're going to talk about something else that's complicated up next. We're going to get into dividing this up. We're going to get actually creative, because I've had lots of cases involving businesses and because both parties, for the most part they were getting along, even though we hadn't settled the issue of the business, they were getting along, we got very creative in coming up with a fair resolution on how to deal with that business inside the divorce. We'll talk about that next.
Leh Meriwether: Welcome, everyone. I'm Leh Meriwether. With me is Todd Orston. Todd and I are partners at the law firm of Meriwether and Tharp and you are listening to the Meriwether and Tharp Show. If you want to read more about us, you can always check us out online, atlantadivorceteam.com. If you want to see a transcript of the show or listen to other shows, you can go to divorceteamradio.com, and there you can also find links to subscribe to us in iTunes, Stitcher, SoundCloud, all those great places.
Leh Meriwether: Okay. Last part. We have gone through, we have valuated the business. We're not going to get into when you've got a contested case and you have two business valuers. Let's say we've got the parties have agreed to the value of the business. What do you do with it? There's lots of scenarios. We'll try to hit as many of them as we can in this show. Let's first talk about where you got a owner and the spouse who's not involved in the business at all. Let's say it has a value of $500,000 and if you were playing things out then perhaps he needs to pay if they've agreed we're going to split everything 50/50, he needs to pay her $250,000.
Leh Meriwether: Problem is, there's not $250,000 in cash. One thing we do as lawyers is we'll look is there someplace that we can balance this out. Now if we were representing the wife, a nice way to balance it out would be to give, so let's say there's $250,000 in equity on the home. Well, we'll say, "Well, she gets to keep the entire equity in the home. He keeps the business." I'm sorry, you would have to say there's $500,000 in equity in the home, sorry. Because he would have half interest in that. So she keeps the entire home with $500,000 in equity because they were smart during the course of their marriage and they paid off their mortgage in its entirety so it's worth $500,000.
Todd Orston: Well, it could be 250, because if the business is 250 and the house is 250, arguably it would be-
Leh Meriwether: Well, no, if the business is half a million.
Todd Orston: Yeah, I know, but if it was 125 and 125-
Leh Meriwether: Oh, if it was that.
Todd Orston: Yeah. Then basically what you're saying is if the business was 250 and the house was 250, rather than splitting both of them, you keep the house, you keep the business.
Leh Meriwether: And that's actually more favorable to the wife because there's an exception to capital gains tax when you're dealing with the residence you're living in [inaudible 00:35:30] real estate.
Todd Orston: But there are other considerations, because sometimes it may not be favorable because sometimes, let's say it's retirement. Well, that's qualified accounts and it's pretax dollars.
Leh Meriwether: Oh, you mean we're going to offset the business with retirement.
Todd Orston: Right, with retirement. So a lot of the things we have to thing about, and where you end up having to get creative is, okay, you're going to keep the business and the business is income-producing and what have you, and all right, I'm going to keep a 401K that I can't touch for 15 more years? Okay, well, that doesn't really work for me because if I need to touch that money I am going to basically have to deal with penalties and taxes or whatever. So if you just gave me let's say dollar for dollar a $250,000 amount for the business and I'm going to get 250 in extra 401K, well, that's going to be deeply reduced if I even can draw down on that 250,000 in retirement because of the penalties and the taxes.
Leh Meriwether: Right, you're taxed on normal income, whereas if you were to sell the business, he's taxed based on capital gains.
Todd Orston: That's right.
Leh Meriwether: But when you're talking about the house, if you're single you get a $250,000 exemption. There is no tax, whereas he's getting taxed if he were to sell his business, he's getting taxed and then depending on the income coming out of the business will depend on what his capital gain treatment is, because it's anywhere from zero to 20% and it can change tomorrow with a new change to the tax law.
Leh Meriwether: So that's the analysis that we work through to try to find something that's a fair way to offset it with another asset, taking into consideration taxes. So that's one thing. The other thing is there could be a payout over time. Well, the problem with a payout over time is that perhaps the business, there's a problem with the business in like our Great Recession, and all of a sudden he can't pay her what he agreed to, but now it's a court order, and the court's like, "Well, you can't bankrupt her. You owe her all this money. I understand the business isn't making anything now, but you still have to pay it."
Todd Orston: Yeah, unless your attorney has done a good job working into the equation language that could contemplate changes in the market or changes in the value of the business. If there is a bankruptcy event, if there is something that basically could be taken into consideration for a future modification.
Leh Meriwether: Yeah, and I will say though that most lawyers on the other side won't agree to that.
Todd Orston: Absolutely, but that's where it gets tricky. That's what I'm saying. The other side's going to be like, "No, you're getting the business. You're going to reap the rewards if you turn it from a one million to a $10 million business." Then I don't care. If you turn it from a one million to a zero dollar business, I still get my money because we're valuing it as of today's date.
Leh Meriwether: So the other option is to get financing, because sometimes you can get that, and obviously if it goes under, well, you'll get sued by the bank that loaned you the money, but you can file for bankruptcy on that, whereas you can't bankrupt out of something arising out of the divorce. There's options. Those are things that we have to work through, and you just got to work through it when you got to get both parties in there to think though, because you don't want to go in front of a judge with this, because the judge doesn't have time to think through it and figure out something that's fair and creative.
Todd Orston: Right, and going back to what I was saying before and what you commented on, you have to think. I mean, we don't have crystal balls, but you have to think ahead. You need to. If you're in a business that has been trending downward, then that needs to be taken into consideration. If you're in a business that's trending upwards, fantastic. Then good for you. But if it's been trending downwards-
Leh Meriwether: Like a taxicab company.
Todd Orston: Yeah, that's right. I've had clients come to me and they have a business and it's like, "Well, three years ago I made $500,000 and two years ago I made $250,000 and last year I made $175,000." Okay, well, if we do a valuation right now let's say the valuation came back at something based on $175,000 of income, but if I'm now looking at a trend, next year's, is that going to be 100 and the year after that it's even less? We need to take those things into account when we're negotiating a settlement because we don't want you to lock into something you can't afford.
Leh Meriwether: Now, sometimes you've got cases where both husband and wife work in the business. You've got to decide are you both going to stay in the business.
Todd Orston: Not a good idea.
Leh Meriwether: Usually not, but I had a case-
Todd Orston: It has happened.
Leh Meriwether: There was a case years ago where they had a series of businesses. They were all the same. It was a franchise. They had something like nine of them, 10 of them, and nine of them were okay, but they decided they were just going to sell them and split them, but there was one that was just killing it. It was outperforming any other in the area, in the region, and they both decided, "You know what? We don't want to give this up. We want to stay working in it." What we did was we crafted a very, very, very detailed operating agreement. This thing was like 85 pages long, and it had all these different "if then, if this, then that, if this." It took me forever.
Todd Orston: You have to deal with control issues. You have to deal with management and all those types of issues.
Leh Meriwether: How to deal with disputes and how are we going to resolve them. It took me forever to put together, but they both agreed to it. They were happy with it. They got divorced, and they never had a problem that I'm aware of. I think they eventually wound up selling that business, but they were able to operate in it for a long time, reap the rewards of it.
Todd Orston: And my comment's not a good idea, that is usually the case.
Leh Meriwether: I agree with you.
Todd Orston: It's the same thing that we say, "Well, we're going to live in the same house after the divorce." No, maybe not. Maybe you shouldn't do that. It might work. I've seen parties where they're still living together six months after a divorce and they're making it work. Okay, then that's great, but on paper it's not a great idea.
Leh Meriwether: Yup. And most of the time we counsel people not to do it.
Todd Orston: That's right.
Leh Meriwether: You've got to do a very, you really have to gain clarity, going back to our last show.
Todd Orston: Absolutely.
Leh Meriwether: You need to gain clarity as to whether this is a good idea, can you operate together.
Todd Orston: And it will call for a lot of, you said, maybe not an 85 page, like if you're living together in the same home you don't need 85 pages of terms, but you're going to need a lot more clarity and concise language so that when a problem or if a problem arises, there is a clear way to handle it. That avoids you having to come back to court and fight in court over something.
Leh Meriwether: Well, the problem is you can't come back. When you're in a divorce-
Todd Orston: Division of property issues.
Leh Meriwether: ... in division of property issues it's [inaudible 00:42:36]. You can't come back to court. You're going to have to go to corporate court basically and boy, that can get even messier than a divorce. Another way we've done this is we've had the business split in two. Again, that created a very detailed breakdown of how they were going to split those two businesses up, who was going to be responsible for what. There was some shared marketing issues, so how do we deal with this phone number. If someone calls in asking for X, Y, and Z how's it getting over to Business B versus Business A, and is Business A going to steal business from B. So that created a lot of effort to make that happen, but it did happen. They were able to move on and both operate their own separate businesses and grow them apart from each other.
Leh Meriwether: Well, unfortunately, we're out of time again. There's actually some other options, but if you do have this situation and you definitely need to call an attorney, this is not something you want to take on your own, because we'll help you with the help of a business valuator figure out how to deal with the business in a divorce. Thanks so much for listening.