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This Month's Article

Challenging the Survival of the
Family Business: When the Owners Divorce

December 1, 2018

In this third of a three-part discussion of businesses as marital assets, we will consider family businesses in which both spouses have a role in the management and operation of the business.  

Family businesses often sit at the very center of the family's financial and emotional life.

It is not surprising then, that divorce and its impact on the future of the family business would be one of the most challenging scenarios for which to structure a property settlement.

The amount of day-to-day energy, care, and financial investment is great in any business partnership. But when the principals are also the owners, the intimacy of these relationships imposes an added layer of complexity, starting with the question of each spouse’s intended future involvement in the business. And all that assumes that the divorce settlement does not result in the sale of the business to a third party. For the purpose of looking at different ways to structure a property settlement, the following cases assume that the business will be retained by at least one partner.

In our first scenario, both spouses share equally control of the business enterprise. Edgar and Davina Forest, are co-owners of two restaurants specializing in continental cuisine--very upscale and very expensive. Edgar is the chef and Davina is in charge of all business operations. Although his is the name that the media herald for his inventive use of traditional cuisine and elegant presentation, Davina is, in effect, the brains behind the scenes.

After ten years of building their business from a neighborhood bar, to starred establishments, recommended by local food connoisseurs and travel guides, their business was operating in the black. Unfortunately, their marriage had suffered from the long hours of work and the seemingly endless conflicts over the constant capital investments needed to develop the enterprise. Even after the restaurants were established, there was no financial relief from non-stop work requirement of the restaurant business, compounded by the intensity of two dedicated entrepreneurs, who are married to one another.

With multiple years of reinvestment and improvements that had been required, the Forests do not have much extra cash in the bank. Indeed, their business is really their principal asset.  The Forests have no retirement funds and no investments to speak of. They do have a house with $200,000 in equity, having refinanced this quite expensive piece of real estate three times in order to raise money for the opening of each restaurant.

Despite the charged tenor of their late-night feuds, ultimately resulting in the decision to divorce, Edgar and Davina were wary of “going public” with their plan to separate. They knew several divorcing couples who had "eaten up” their assets in legal bills, not to mention the ugly rumors that practically destroyed their businesses. Knowing all too well, the destructive path of bad publicity, the Forests chose, albeit with trepidation, the confidential path of mediation as a means to reach a divorce settlement.

In mediation Edgar and Davina explored a variety of different options, all focused on retaining their businesses. Although at first they considered keeping the business structure as it presently operated, reluctantly they came to the conclusion that their individual need for control, leading to frequent volatile personality clashes, was simply  not conducive to maintaining a cordial and cooperative post divorce relationship. The mediator urged them to think of  the present and also of the future. What would happen if the business needed infusions of capital? What if either one or both remarried? What if one wanted to sell the business and the other did not have the funds for a buyout? And so on and on, they pondered. The end result for Edgar and Davina was for each one to retain one restaurant. Even given their complimentary and very distinctive skills, a continued relationship did not seem feasible to them. Interestingly, once the decision to separate--personally, financially, and "business-wise" --was reached, Edgar and Davina were willing and indeed able to cooperate easily and well in the separation of the two restaurants. Davina helped Edgar's newly hired business manager to establish operational systems to manage and oversee the restaurant, giving Edgar the freedom to be his "creative self." And, too, Edgar helped Davina in the search for a chef who would be embraced by the restaurant's clientele. yet who possessed a style quite distinctive from, and not threatening to, Edgar's. Sounds like a fairy tale conclusion? Maybe, but good endings often result when couples work together, despite, and in spite of, emotion, fear, and even anger, to fashion a settlement in which both parties emerge as winners. For a successful mediation, both parties need to focus on each other's well being. The end result is successful only if both husband and wife emerge whole. There is never anything to be gained financially, or even emotionally, from the defeat or downfall of one spouse. Edgar and Davina, as others, realized that their present dependency needed to be converted and reshaped in order to salvage the successful business that they both built and, in so doing, allow each one to build a promising future.

Our second scenario also focuses on marital partners as owners who work together in the family business. Here, the difference is that one owner is in effect the principal of the business and the other owner cast as having a supporting role.

Stan and Phyllis Oliver provide an excellent example of this category. Stan, at the age of 23, just out of college with a business degree, jumped at the opportunity to buy a local pizza shop being sold by a friend of the family. Stan had inherited some money upon his grandfather's death and with no other opportunity or job prospects, the pizza shop seemed a promising  purchase. With much hard work, the shop did indeed prove to be a success. One shop grew into four, all situated in suburban towns with affluent and pizza-loving residents. After Stan's marriage to Phyllis, she, too, became involved in the now family business. Phyllis helped manage the books, pay the bills, and oversee staff when Stan was busy elsewhere. They worked hard and well together. Phyllis had no interest in running the business, did not wish to oversee, even less, spearhead its growth. She was content to leave the management of the shops to Stan; there was little conflict or tension in their working relationship. Still, their marital life was less than idyllic. Stan's life was centered on the business; Phyllis wanted a family, and a house in a suburb with good schools. With little outright conflict, the Olivers decided that their marital goals were irreconcilably different and as such agreed to divorce.

Here the situation to be confronted in the divorce settlement was much different than with the Forests. Phyllis enjoyed working for Stan. She did not feel vested or even invested in the business. Mediation presented the alternative of choice. Stan, whose parents had a rather ugly divorce when he was in his teens, wanted no part of a battle. In particular, he feared having to sell the pizza shops to settle with Phyllis. Fortunately for both Stan and Phyllis, the story had a different ending. To Stan's surprise, Phyllis wanted to continue to work for him and to his even greater surprise, Phyllis had no immediate need to receive her interest in this family business. Based on an evaluation of the marital portion of the business, in which Phyllis had an interest after consideration of Stan's initial investment, Phyllis allayed Stan's fears of demands for a buyout which would force him to mortgage the stores or to raise moneys from outside investors. After discussing various options in mediation, all of which were geared toward ensuring the profitable continuation of the business and Phyllis her full entitlement, the Olivers designed a buyout schedule that Stan could afford to maintain and that would provide Phyllis with an investment return as long as moneys were owed to her. Stan  had an incentive to buyout Phyllis's share as soon as was feasible for him, and Phyllis was fully satisfied with having an investment that provided her with a monthly return and an annual lump sum payment. To further enhance the deal, Phyllis' willingness to stay on as bookkeeper to the business and all around back-up "man" for tasks that Stan had neither the time nor inclination to perform, was to Stan, the icing on the cake. As an employee, Stan thought Phyllis was the best, and not to forget, where would he find someone whose honesty was so impeccable? As a working team, Stan and Phyllis never had a problem. Mediation provided the Olivers with an equitable and workable plan to divide their marital holdings, including the most valuable asset of all--their business. Perhaps as important, mediation presented the forum for this couple to continue their working relationship, a relationship financially and personally valuable to retain.



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