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FAQ: What Happens to a Small Business During a Divorce?

Michael Tierney
February 17, 2023

We spend our entire lives building our careers and lifestyles to enjoy a future without worrying about certain issues. While many elect to seek employment with existing industries, others fill the role of self-starters and create new businesses. These new businesses are usually smaller than the typical retail giants our society commonly utilizes for their needs. These small businesses are therefore plagued with a lack of resources that the larger industries can easily acquire while their smaller rivals struggle to finance them. Nevertheless, several small businesses enjoy success and remain staples of local communities across the country. Unfortunately, one issue can impact even the most successful small business.

Marriage is an important legal contract where two citizens with longstanding romantic connections can share their lives. This means sharing resources, finances, and property with someone with whom you share a profound connection. The problem is that several marriages end in divorce, and you are expected to sacrifice a portion of your property to your spouse's control.

When people hear "asset division," their minds usually go to furniture or money, but some might not realize that their business is vulnerable.

Solution Small businesses are affected by divorce proceedings in the same way as any other property associated with marriage, though some provisions exist to protect certain businesses.

The question is: what exactly does that mean?

What is Marital Property?

When a couple divorces, they are expected to divide property between spouses, so neither is left without their due. While most popular media portray asset division as a disproportionate distribution of property, there is more logic behind the process than people realize. According to civil law, the property in a couple's possession can be divided into 2 categories:

Separate Property: Separate property is anything owned by one spouse with no connection to the other. The property considered "separate" is defined differently depending on the state. While this makes identifying a separate property in your area difficult, there are a few universal qualifiers:

  1. The property was owned by one spouse before the marriage.
  2. The property was a gift or inheritance bequeathed to one specific spouse.
  3. The property is specified in a legally binding document (i.e., a prenuptial or postnuptial agreement) as separate property.
  4. The property was awarded as a personal injury settlement as compensation for pain and suffering.

Marital Property: Marital property is owned by both spouses or to which both spouses have a legal claim. Like separate property, marital property is defined by state ordinances that can change from one end of the country to the other. However, universal requirements are likely to affect any couple's situation.

Marital Property

The biggest requirement is that marital property is exclusively acquired during the marriage. This helps protect the aforementioned separate property from being dragged into the asset division negotiations. That said, separate property can become marital property if it intermingles with marital property.

The most concise example of a separate property becoming marital property is when you combine separate funds with marital funds. While most money accumulated during the marriage automatically becomes marital property, inherited money or money kept separate for the entire relationship usually retains a separate status. Once those funds are transferred to a jointly controlled account, they become marital property.

The distinction between separate and marital property is critical for anyone going through a divorce. Only marital property is considered for asset division negotiations in a divorce, which is why the important or sentimental property should be kept separate or listed as separate in a prenup. Otherwise, anything and everything you own could become marital property and be subjected to negotiation in divorce proceedings. The question plaguing small business owners is whether their businesses are affected.

Are Small Businesses Marital Property?

With marital property being one of the points of contention in divorce proceedings, many people elect to bury themselves in their work after a divorce. Unfortunately, this might not be possible for small business owners since the business could end up on the negotiating table.

Solution Before you get too worried, you should know that your business is not automatically at risk, and you might be able to retain full ownership.

Nevertheless, several factors could give your future ex-spouse a claim on your business that will lead to negotiations. Small business owners usually create their services or store themselves before getting married. Sole proprietorship is common for small business owners since they usually lack the reach necessary for multiple owners or a board.

Unfortunately, sole proprietorship of a small business is not necessarily enough to protect it from your spouse's legal team. There are circumstances where your spouse has a fair claim on your small business, though usually only when they played a role in its development. If you founded and operated the business independently without any assistance from your spouse, it is considered separate property. So long as a small business is a separate property, the business is not eligible for negotiation during divorce proceedings. At most, your spouse might get a portion of your earnings due to spousal support payments, but that is another topic entirely.

The situation radically changes if you and your spouse were married when the company was founded. If your marriage precedes the creation of your business, it will likely be considered marital property since your spouse was a part of your life when the business was created. This is not guaranteed since some states prevent this while others allow you to keep the business as separate property despite your marriage. More often than not, the business will be considered marital property.

When a small business is identified as marital property, your spouse can maintain their stake in the company's interests and attempt to retain partial ownership. Generally, this means your spouse is entitled to a half-share of the business and could retain a degree of control after the divorce. At the very least, your ex-spouse would be entitled to half the company's earnings. While most small businesses only become marital property if founded after the marriage, a pre-existing small business can be converted into marital property.

Dividing Marital Property

When a small business owner gets married, it is common for their spouse to become involved in the business. Usually, this is because their new spouse has a skillset that directly relates to the business or can assist with clerical tasks. Hiring your spouse as part of the business can transform your company into marital property despite you being their boss.

This is because a spouse who contributes to a small business is involved in its success or failure. As a result, they have staked a claim in the business and are entitled to a fair share in the business despite the divorce. You do not even have to officially hire your spouse for it to become marital property. If your spouse contributes to the business in any way after the marriage, your small business could go from being separate property to marital property.

When a small business becomes marital property, it is considered fair game during divorce proceedings. While your ex cannot take control of the company away from you without your consent, they might be entitled to become your business partner. They will have a chance of winning 50% of the company under your control and will likely have a long-term stake in your business.

The specifics will vary by state and circumstance, but generally, your small business has a high chance of ending up on the negotiating table if your spouse contributed in any significant way. This means the biggest question you need to answer is how to shield your business from falling into your spouse's hands so you can retain full control.

How to Protect Your Small Business

Divorce negotiations thrive on asset division between spouses and are designed to split resources fairly. Unfortunately, "fairly" does not necessarily mean "equally," and asset division can occasionally favor one spouse over the other. This means assets that could theoretically be divided down the middle might be weighted in one spouse's favor because the other is in a better position financially.

Small businesses are not so easily divided since one spouse might have been responsible for its creation while the other might not have the skill to operate it properly. Unfortunately, this does not prevent your spouse from having a fair claim on your business during the divorce process.

Solution The only real way to protect a small business from asset division is to keep your spouse away from the business altogether. So long as your spouse does not contribute to your business's operation, they cannot claim any percentage of the business. The best way to cement this is to file a prenuptial agreement before marriage to secure your business as your property.

A prenuptial agreement can define your business ownership, while your spouse agrees to forgo all claims to it in case of divorce. Prenups can even prevent your spouse from accessing business finances or acquiring support from the income generated by the business.

A Small Business Owner

If the business was founded after the marriage or your spouse contributed to the business's operations, their claim is more or less cemented. If your business is marital property and becomes a topic of negotiation, it is still possible to preserve complete control. Unfortunately, this requires you to forfeit other assets equal in value to the portion of the company your spouse would be awarded.

For example, if your spouse has control over $20,000.00 worth of the company, you would need to replace it with $20,000.00 worth of other assets to compensate them for what they are surrendering. This is only required if your spouse has a legitimate stake in the business.

You might wonder if situations in which infidelity plays a role can alter the division of your business. Most courts frown upon infidelity and will usually favor the victim over the perpetrator during negotiations. This does not mean that infidelity directly affects child custody or asset division, but it can affect how quickly the negotiations settle. You might see television programs or read books where a cheating husband loses his business or house because he cheated on his wife. However, asset division does not work this way, and infidelity on your part or your spouse's will not skew the division of your property (your business included) in one direction.

With all this in mind, protecting your business from being divided between you and your spouse requires preemptive action. In some cases, it is possible to create a postnuptial agreement to protect a small business founded after your marriage retroactively. This option is rare since businesses founded after marriage are usually as significant to your spouse as they are to you. Nevertheless, knowing how your small business can be affected by divorce is critical to determining how the negotiations will proceed. Unfortunately, this is a niche component of divorce, and there are other major issues you will need to consider.

Learn the Law

Small business owners have the deck stacked against them since larger rivals have greater reach and more resources. As a result, these smaller businesses are forced to fight tooth and nail to keep what they have. While facing off against larger companies is extremely challenging, it can be easier compared to protecting your business from falling into your spouse's hands. Divorce negotiations could pry half of a business owner's hard work away from them and place it squarely in their ex-spouse's hands. Unfortunately, this is only one specific issue that might affect your divorce, and there are other, more common scenarios to consider.

A Person Learning the Law

Divorce is one of the most challenging and disruptive civil proceedings in the judicial system and can devastate an unprepared citizen. Divorce forces us to go up against someone we once loved, who might view winning a better divorce settlement as more important than a fair one. Even if your spouse is not prone to manipulating the divorce process, divorce itself could still blindside you with scenarios you never considered. Learning more about divorce is the best way to defend against potential issues that might arise in your case. We realize this is a difficult time, but we hope this article was helpful.

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Written By:
Michael Tierney

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