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Preparing for divorce: business owners


Listen as we discuss: what to do before you get married to protect your business; mediation and litigation if you’re going through a divorce; how owning a business could affect a divorce settlement; buy/sell agreements in the event of a divorce; and understanding separate vs community property. Guest host: Leslie Satterlee, Attorney, Partner at Woodnick Law

Michael Carlin

This is Michael Carlin, President of Henry+Horne Wealth Management with your Manage the Funds Podcast.  Joining us today is Leslie Satterlee from Woodnick Law Offices. This is a big day for us and for podcast listeners. We have a deep dive to explore – so deep we need to break this into two parts. Most of our clients are business owners and business owners face an unfortunate reality. Because many of them are married, many of them go through divorce and virtually none of them are prepared for what’s in front of them. What my hope is today is that we can start to lay the foundation for what they need to think about before, during and after about that whole thing of owning your own business, and how to prepare better for that divorce.

With that, let’s talk about Leslie for just a second. So, I learned what a judge pro tempore is and you fill in for that roll. Graduated Sandra Day O’Connor School of Law, Super Lawyers Rising Star State Bar AZ, Outstanding Lawyer 2001. I have a huge bullet point list.  Should I go through them all?

Leslie Satterlee

No, you don’t. All the people listening need to know is that I’m a family law attorney and I work for Woodnick Law where we focus on the family. All I do is family law; it involves divorces, custody and a big focus of what I do and clients that I help are business owners. So, I’m happy to inform people.

Michael Carlin

Let’s get into some of the unfortunate and necessary divorce statistics. The national divorce rate for first time marriages is 45%-50%. This is the average divorce rate. The divorce rate goes up significantly for those of you in your second and third marriages. Second year marriages 60%-67% fail. If you think that’s bad, try being married a third time. Those marriages fail 70%-73%. The numbers aren’t great. What’s challenging to me is the majority of listeners are in Arizona.  t’s a great place to live and the weather’s terrific, but we live in a state where we have the highest divorce rate in the country. More than 60% of marriages end up in divorce. Statistically speaking this is a nightmare.

Leslie Satterlee

Yes, unfortunately speaking, it’s something that everyone who is married also needs to keep in the back of their heads. Hopefully it’s something they never have to worry about, but it’s something to plan for, especially if you’re a business owner as well because you have more than W-2 income you’re protecting. You have a business. You have what you’ve been living your life to build up. You have to keep that in mind.

Michael Carlin

People who own a business may forget that there’s a difference between someone that earns a nice living and gets a really nice paycheck then divorce happens versus a business owner that earns the same living as that employee who is getting a divorce, but because they own a business there’s more to that process. It’s not as simple

Leslie Satterlee

That’s correct. We could have on paper someone who looks exactly the same from an income point of view, but their divorce is going to look substantially different. We have done divorces that range from people who are sole proprietors, insurance agents, to people in law firms, to people who own manufacturing businesses. It runs the gamut. Even those sole proprietors who work from home think, if I stop working from home there’s no business and no value. That’s not the case in Arizona. That’s something to be mindful of.

Michael Carlin

Some business owners think if that’s the case, I’ll just shut my business down and start a new one, but it doesn’t always work like that because if it did then everyone would do it.

Leslie Satterlee

We refer to that as bluff the nuclear option. I’m going to stop working, do something else later. The problem is the court can look at what were you doing before and there is a value to that and now you have intentionally stepped away from that and now it’s almost a waste of a community asset which is a legal term, community waste. They can still put a value on that and you would still have to pay half to your soon to be ex and, on top of that, they can also make income and we are going to impute that income back to you and now you’re in real big trouble

Michael Carlin

Also, to the same degree, the only right way for the other spouse to protect themselves from being railroaded.

Leslie Satterlee

That really is the issue. It comes down to equity and fairness in Arizona so, yes a business owner could do that but then the spouse is going to be in a world of hurt because they have been there all along during the marriage to help build it up even if they were taking on different duties in the household or raising kids and not necessarily in the nitty gritty of the business. They are still entitled to it and that’s how the Arizona law works.

Michael Carlin

Is there anything to be said about the historical precedent because it seemed like years and years ago the men in these divorces would get away with different things and those laws and rules have changed to be fair. Is there any truth to that?

Leslie Satterlee

That may be why one of the reasons here in Arizona with community law principals and being a newer state, so to speak, than other places in the country; it’s always been that way here where you are looking at anything accumulated in the marriage as community property and that will be divided more or less equally. Then there is this notion of support on top of it – could be another podcast.

Michael Carlin

Help us walk through some of the things we need to do first before we leap in and get married.

Leslie Satterlee

The one thing that I would recommend is to talk to your fiancé about finances. You need to understand and be on the same page as how money is going to work during the marriage. For protecting your business because you have one that started before the marriage, that’s going to be separate property but that doesn’t mean that it will forever and always stay your separate property without any community interest in it once you get married. If you’re really concerned about that, I would strongly consider a prenuptial. That’s one thing you should really be looking at.

Michael Carlin

How do you start a conversation on finance from your perspective as a divorce lawyer?

Leslie Satterlee

I think starting the conversation about finances is saying, hey look, I have this business here and I want to be fair with everything, but I also don’t want there to be this looming disaster on the horizon if something ever happened to our marriage. Hopefully it’s only a piece of paper that we are having to sign and never have to look at, but I want us both to understand what’s going to happen later if it doesn’t. I think you have to approach from that point of view.

Michael Carlin

It’s not very romantic. Hopefully you will spend some time drawing it up and you will need a lawyer to get it drawn up to lay out the rules of the road for the business.

Leslie Satterlee

So, let’s talk a little bit about your example a few minutes ago about owning a business before you get married.  Let’s say you have that business and its up and running. You get married and it’s still going and it’s still in place at the time a divorce is looming in the horizon. That business, because it was started before the marriage, will stay your sole and separate property. The problem is there is going to be a potential community component to the growth of that business.

There’s a case here in Arizona. If you have a business and you’re headed for divorce, you should familiarize yourself with this case. Essentially what it is, did that business grow during the marriage because of natural market forces or was there any community effort that was put into the business during the marriage? Whatever was a portion to the community effort so to speak is going to be what the community interest is in that business.

Michael Carlin:

Community effort. So, if you’re the business owner, you say community effort – seems a little vague. How do we make that with the practical meaning of community effort? Take us through that.

Leslie Satterlee

It could be so much as you still getting up every morning going to the business and working on it, or you’re investing more into it. Doing things that are a more active role in the business. Any work or effort that you’re putting into it during the marriage is community effort even if it’s just you and not your spouse.

Michael Carlin

What if the spouse does not go to the office?

Leslie Satterlee

Doesn’t matter.

 

Michael Carlin

It’s a different form of community effort. That business owner would need to be, again we are presuming that the other spouse is home maybe or maybe not taking care of the kids and doing those other kinds of things, so we’re assuming that is the community effort and that entitles you to 50% of the growth of the business

Leslie Satterlee

So, you can see the complexities that start to come into play. If you’re figuring that out and you’re trying to parse that out, you need to figure out how much was the business worth at the date of marriage, how much is it worth at the date of divorce, how much has it grown in the interim and what portion of it is active versus passive, so to speak.

Michael Carlin

Did we figure out how much the business was worth in the first step before the marriage? Did we do that and is that part of it?

Leslie Satterlee

More or less. If you could try to get the documentation in place, that would be able to establish that later on.

Michael Carlin

Here’s the revenue. We’re going to take a snap shot of the financials

Leslie Satterlee

Honestly, from a business on all of your assets, make sure you have that information because trying to reconstruct it if you’ve had a 10 to 20-year marriage, that’s hard to do.

Michael Carlin

Right, because you know how long a bank keeps your statements.

Leslie Satterlee

Usually one day less than what you need.

Michael Carlin

I say seven years, but if you have your money at our firm, JP Morgan or Wells Fargo and your assets were to be transferred and not there, those institutions may not keep them for six or seven years. So, your keeping copies of everything and your understanding the money that’s gone into the business and the money that’s gone into those accounts. Should we begin to unpack the money that’s gone into the business?

Leslie Satterlee

So, money that’s gone into the business, I mean again, there is going to be arguments that that has increased the value for one reason or another. If you have a business where you’re starting to invest a lot more, that can take on many different forms as well. Maybe you’ve taken on another aspect of the business, you’ve reorganized it – you’ve got to keep records of that and be careful of what you’re doing. So, as you’re doing this during the marriage consulting with your financial planner, I’m not saying that you should be consulting with a divorce attorney if you’re happily married, but these are things to keep in mind.

Michael Carlin

So, a person who owns their business before they’re married, and they are married for seven or eight years. In terms of money that has gone into the business, that is something to keep track of in terms of that we can show that they reinvested. They could’ve taken more income out, but instead they put $100,000 in. Is that something that’s evidence?

Leslie Satterlee

That’s where sometimes then the forensic accounting gets involved. Where did that money come from? Did that money that was reinvested come from separate property, or from profits from separate property or did it come from community money or money that was made strictly during the marriage from joint efforts? So, it really becomes an issue of figuring out where the money is coming from. The more you can keep everything segregated into separate buckets – the separate property created the separate profit, that separate profit that went back into it that separate property, that keeps it cleaner. Unfortunately, that doesn’t happen.

Michael Carlin

How many clients have you seen that have operated in a way where they say, I wasn’t sure of this now, but I’m just going to have to work it. I’ve always been tracking it with a solace – has this happened ever?

Leslie Satterlee

No. Honestly, when people have prenups, it’s hard to get them to follow the terms of the prenup. You just have to be diligent about managing and watching your finances.

Michael Carlin

So, when a business owner has a prenup, it’s a little different, or is it the same process you would take with or without a business owner?

Leslie Satterlee

If you have a prenup with the business, it can be completely different. It could be a big game changer for the business owner, because you can clearly say, this business is forever and always 100% the business owner’s even if there’s profits, even if I’m working there as a business owner, even if my spouse comes in and helps manage the books here and there. It’s still my separate property. So, you can really lay out the terms in a prenup and protect yourself along way with that.

Michael Carlin

How do you make that prenup for the owner more solid?

Leslie Satterlee

With any prenup, one of the biggest issues is full disclosure. So, if you want to make that prenup enforceable, you need to make sure there is full disclosure so that both sides know exactly what’s going on. The other thing is both parties need to have independent council. That is a huge thing. Make sure that both soon to be spouses have consulted with their own independent attorney about this and understand it.

Michael Carlin

That spouse will say, (the one who doesn’t have the business) alright, I trust you with your business. In the beginning that’s kind of what’s said, right?

Leslie Satterlee

Right, and that’s where you need to insist that we need to go talk to someone, find an attorney, have them review it, and I want to make sure you know what’s going on. Hopefully there is that independent review that is going on. The other thing is, do not try to get it signed on the way to the chapel. You want to get it done in enough time where there is not going to be an argument that it was coerced, or that there was duress, or if you don’t sign this I’m not going to show up in five minutes at the altar.

Michael Carlin

I thought that was what the tray tables were for on the airplane. No?

So, divorce is approaching – we need to figure out because you are a business owner there’s two from what I’ve seen – two major decisions. Am I going to do mediation or am I going to do the mediation route? As a business owner, and having clients that own their own business, it’s an extra burden because you’re not just making an income, you’re taking care of employees, you’re taking care of clients and trying to move your company forward. Those people that think they are going to litigate this thing to death, one of the things that I would encourage you as a business owner is the emotional toll that litigation can take versus the ease of a mediation.

Leslie Satterlee

I’m a big proponent of mediation. Meditation especially for business owners, or the high asset clients, is beneficial in many ways. One, you can keep things more private in mediation, which is a big deal for business owners and people with a lot of assets. They don’t want all their dirty laundry aired or in public records. The other thing is you can dictate the timeline a little bit better.

With litigation, for better or worse, it’s going to be a more drawn out process by the time you get full on trials and hearings, especially in Maricopa County. They’re very crowded dockets. The judges have 900 cases given to them at any given time, so the likelihood of them having time to understand your business is low. So, mediation you can pick a mediator who has a lot of experience in divorce and high asset cases can be very beneficial to you.

Michael Carlin

Let’s put ourselves in the shoes of the person who does not own the business and they are dealing with the business owner that’s being an “A type” entrepreneurial personality, domineering, railroading – are there cases where that spouse needs litigation?

Leslie Satterlee

That certainly is one aspect and each case is unique and there are pros and cons to both routes. Mediation is a “it takes two to tango” approach. You need to have both parties that are acting reasonably in order to make that work. So, sometimes even when someone is very motivated to go to mediation, you still end up in litigation because you can’t reach an agreement. The litigation route also might be necessary because there are just completely unrealistic expectations from one party or the other. It could be a power struggle sort of issue like you insinuated.

The thing with the spouse that is not the business owner is that they should be pushing for a business valuation if they’re concerned that they don’t have sufficient information, if they don’t understand the business or that they don’t know what the value is. A business valuation is the way to go whether it’s court ordered or it’s an agreement by the parties that there’s going to be a business valuation, because you have an expert looking at everything and giving their opinion as to the value of the business and that’s the starting point for negotiation and mediation or litigation.

Michael Carlin

That’s what we run into a lot. When we do divorce cases, typically we end up working with the spouse that doesn’t own the business and needs to go out and establish a whole new team of professionals behind them to get prepared. I still think that mediation is the way to go. It helps things not to get crazy.

Leslie Satterlee

At least find attorneys that realize the cost benefit of taking different approaches in a case. So, in an ideal world, both parties have attorneys who can come together and discuss, hey look, this is how we are going to move forward with establishing the business, with exchanging information, business records and financials documents and you’re working towards that. You can’t always control what is happening on the other side.

Michael Carlin

If you are considering hiring an attorney, or hiring an attorney who is looking for blood, understand that comes with a cost. It comes in an emotional cost for the person who signs up for it and the person who is going to face that attorney. It can complicate processes.

Leslie Satterlee

I think one of the good things for any parties who own a business, whether it’s the person operating the business or a spouse who sees the business from the outside at least a little bit so to speak, they might understand the cost benefit analysis that goes into it. Unfortunately, it is a breakdown of a family and marriage and that’s very emotional, but at the end of the day, when we are talking about the business and financials, it’s a financial issue and it’s to be treated much more like a business situation than a personal one.

Michael Carlin

So, we need to replay most of what Leslie says, which virtually is everything that she says in this podcast especially that. Not letting your emotions get the best of you is some of the best advice that I could imagine giving in this kind of situation. I want to spend a minute or two to talk about spouses that work in the business during the marriage. It does seem that it complicates things in several different ways.

Leslie Satterlee

It can, and I’ve been involved with cases where the spouses are able to put those personal differences aside and, for the sake of the business, can continue to operate it while the divorce is happening. The considerations once the divorce is being finalized and who is keeping the business, is someone going to continue to work there, which usually is a recipe for disaster but can happen and I’ve seen it happen. They love the business more than they love the fight or is one them going to be bought out and at what price. The other more contested issues to be careful of is what happens if you’re not able to work together and continue to work in the same business while divorce is pending? There could be a situation where the court has to get involved with temporary orders on how the business is to operate. Worst case scenario, receivers may have to be appointed, and that would be a worst-case scenario, but if you really cannot figure out how to operate the business and both parties are doing things to sabotage each other, the courts are going to come in and protect that asset.

Michael Carlin

Now I see why the courts have such a back log. Help me understand. We have this spouse that is working in the business and getting paid. Let’s assume in this scenario that I’m describing that the spouse earns a salary and they are no longer going to be employed by the business, which I think would be more common. The business owner is going to continue to own the business and continue to get their draw from the business. What happens to the person that does not draw a salary? Do they get special treatment?

Leslie Satterlee

Again, part of it can be an arrangement that they’re not getting that salary anymore because they are not working there and its instead while the divorce is pending and turns into some sort of temporary support. I’ve seen cases where the salary continues to be paid even though they are taking a less active role, working from home a little bit more to make it easier, but again, when you have these situations where both parties are involved in the business the other big thing for a business owner to consider is how are you going to inform and if you’re going to inform your business and employees about what’s going on? You don’t want to have any issue with them feeling nervous about what is going on. They leave the business or quit and go elsewhere because they see rocky times ahead and you want to make sure you are doing everything as amicably as possible and as smartly as possible in order to preserve it. Again, preserve the asset.

Michael Carlin

What’s the best way you’ve heard or seen a couple working in the business break it to their employees?

Leslie Satterlee

If the couples are at a high level of communication, they will try to keep things completely out of the business, work it out on the interim and figure out if they are still there or not in the business or both working. Then let it be known to the company as late in the process as possible because they’ve agreed to what’s going to happen. That’s not always the case, so if there is uncertainty, or they don’t know letting them know that the business is going to continue in some fashion, if they know that at least one party is going to be buying the other one out. Yes, there is a divorce going on. We’re not going to let it affect the business. Make sure it’s going to be conveyed to the employees in an optimistic and positive manner.

Michael Carlin

Is there anything we need to talk about regarding that business owner paying themselves a reasonable wage? I’ve run into that with clients where it’s deemed that they weren’t paying themselves a reasonable wage and that kind of impact on divorce gets kind of tricky for business owners.

Leslie Satterlee

Yes, it does, and it plays into a couple of different categories of issues in a divorce context. One, are you paying yourself a reasonable wage, and that could either be adjusted or not in a business valuation context. If you’re trying to figure out how much is the business worth, and you’re looking at an income approach, then they might be looking at how much revenue is there at the end of the day. So, how much is someone paying themselves? Is it a reasonable salary or not could get adjusted.

Likewise, if you’re having people on payroll that aren’t really doing work in the business, that kind of stuff can get adjusted as well. The other place that reasonable salary ends up popping up is figuring out a business owner’s income and that is relevant for spousal maintenance and child support purposes. You want to be as reasonable and on target as what the industry provides as possible.

Michael Carlin

It isn’t just about running a profitable business and earning a great income, because when you go through a divorce, everything is put under a kind of microscope.

Leslie Satterlee

Right, what was fine during a marriage to when both of you were on the same page is all of the sudden not fine when you go through divorce. So, as the divorce is looming, make sure your profit and loss statements are up to date and accurate. That’s going to go a long way. I’ve had many cases where there are small mom and pop shops, sole proprietors that do not have profit and loss sheets. Here is my shoebox of receipts. Then you have to reconstruct what is going on just makes it that much more complicated. So, try to get everything in order, keep good records and be ready to disclose that stuff. Even paying the car lease through the business is totally fine during the marriage, but all of the sudden it’s questionable because it’s a fun sports car and it’s not really for business purposes, so everything is going to be under the microscope.

The other thing – I think it’s important for business owners because they have a propensity to want to sell themselves and their business – like our business is going great, we have all these opportunities? I caution my clients when they’re about to go through a divorce about how to optimistic they are about their business to their ex-spouse as well as to the world. When you’re looking at the value of a business, they are looking at what are the risks going forward, what’s the potential going forward? You want to be honest and say, look there is the pending lawsuit, or I had this regulation violation. Those are the things that are going to help minimize the value of the business. Just be careful.

Michael Carlin

Act more like Eeyore from Winnie the Pooh. I want to spend a moment talking about buy/sell agreements and how they can help. Business owners believe that buy sell agreements are between partners and what if a partner dies? Those are the kind of context that business owners are comfortable with. Can we take a minute to talk about what a buy/sell agreement would help to do in a divorce?

Leslie Satterlee

The context that I come about this from is usually cases where the party is not completely on the same page. So, if you have any kind of business documents where you have laid out if there’s going to be a divorce and this is how the spouse is bought out of the company, that could work if everyone is on the same page and they agree to follow it. If they don’t, and it ends up being an issue in family court or litigation, it is likely that the court will reject that specific term on how you value the spouse’s interest because it’s not in accordance with the actual accounting principles for business valuation. So, be wary about relying on that to establish the value of the business.

Michael Carlin

So, I followed the guides, I got a prenup, we set the business value, we set the formula and the schedule on a buy/sell agreement and how often is the formula followed?

Leslie Satterlee

Within a buy/sell agreement, that formula, it’s rare. Unless it is very clearly tied to one of the more accounting principles, then it probably wouldn’t be. It’s a good guideline. It’s still something that is probably a good idea to keep in all of your business documents. I have seen it be followed even with larger businesses where there’s multiple locations. I’ve seen parties agree to use that method, but it doesn’t always happen that way. Let’s assume there isn’t a prenup in place and you have this after marriage document – if it doesn’t adhere to all the rules for qualifying as a postnuptial, it likely will not be followed.

Michael Carlin

So, buy/sell and postnuptial agreements are different things, or do we need to blend them together?

Leslie Satterlee

Two different things. If you want to try to get a buy/sell agreement to comply to postnuptial rules, I still think you have problems. There is a case in Arizona where they talked about estate planning mechanism. Transferring assets between trusts in and of itself says, if it doesn’t actually follow postnuptial rules, we are not going to follow what you just did during a divorce to try a segregate separate properties versa community property. So, postnuptial – similar to prenups, different in that you have higher heightened duty to your spouse at that point. So, if you’re entering into agreements, you need to have more consideration. You still need to have that full disclosure and you still need to have independent counsel. So, it’s harder to enforce once you’re married.

Michael Carlin

Point here is you need to seek professional guidance throughout. Remember, it’s not about the income. It’s about the employees and taking care of your clients. It’s about the future growth of your business. I think business owners need to meet with a lawyer when you are getting married and meet with them at several different intervals. Find and establish a relationship with a divorce lawyer so you can start to establish best practices for your situation. Statistically speaking, most marriages don’t last.

Leslie Satterlee

On top of those divorce attorneys, keep those financial planners, keep your CPA, keep your tax attorneys – those are all the relationships you’re going to need to rely upon. They are integral along the way. These are all important pieces to the puzzle.

Michael Carlin

We need to talk about the settlement. So, you have this business asset that has a value and you thought of it as a paycheck. But it’s more than that.

Leslie Satterlee

That’s the hardest pill for business owners to swallow. Even if a value is put on the business doesn’t mean that you have that cash available to pay out to your ex. So, where is that money coming from? This is where mediation can be helpful because you can be a little more creative on how you’re paying this off. You need to be thinking about what other assets do you have that you could offset. Can you give more in bank account money, can you give more in retirement money? Then you need to figure out the tax consequences of where these buckets of money are coming from. If that’s not possible, is it going to be some kind of judgement that you have where you’re paying it out over time, and if you are, is there an interest rate assigned to it and what kind of security do you have in place for it?  These are things you need to think about.

Michael Carlin

The experience that we have where the business owner, they have a home, they have investment accounts, and the business owner losses the house and keeps the business and loses the business accounts and somehow from a financial perspective is in a different and sometimes worse place than they were before the divorce went final.

Leslie Satterlee

It ends up being the cash flow problem. That’s where all of your other professionals come in handy. If you’re awarded these assets versus these assets, this is what it’s going to look like for you going forward.

Michael Carlin

That’s why getting that business valuation is critical. Setting that business value to high can be costly and challenging financially for business owners. Is there any nice bow you can put on this for business owners?

Leslie Satterlee

The thing to keep in mind is you have a business and you’re successful for a reason. That’s not going to end when the divorce is done. You’re still going to hopefully have the ability to make that revenue and income going forward. If it doesn’t make sense, look at other options. Can you sell the business, if there something else you can do in the interim? With a divorce, it’s not a happy situation but our goal is to get you to your happy 2.0 and better self at least in the future, if not the immediate future.

Michael Carlin

Good advice Leslie. Thank you so much for guiding us through this. This is going to conclude our divorce special for business owners. Stay tuned because we are going to bring to you shortly our podcast on how to prepare for a divorce from a financial perspective.