Going through a divorce or separation is very stressful for any couple. It can be particularly painful if both parties own and operate a business together. Although there are instances where the parties elect to continue to run the company even though their personal relationship has broken down, this is very rare. The company is often required to be sold or transferred from one owner to the other.
In order to assist business owners going through a divorce or separation, we have answered some of the questions most commonly asked by others in the same circumstance. If you need help selling a business, contact Nash Advisory.
What is considered a relationship?
Before we begin, we should outline what is considered a relationship in terms of divorce or separation, based on the laws in Australia.
De facto relationship
A de facto relationship is one in which a couple lives together on a genuine domestic basis. The couple can be same-sex or opposite sex. A couple by marriage or who are related by family cannot be considered to be in a de facto relationship. However, if a person is legally married they can still be considered to be in a de facto relationship with another person they are not married to.
In order to be considered a de facto relationship, the couple must be living together for at least two years without separation. However, if there are children or substantial contributions to joint property then exceptions to this rule can be made.
If during the relationship (married or de facto), one or both partners operate and run a business then there may be claims over the value of that business should the couple decide to divorce or separate.
What to do if you have decided to separate from your partner as a business owner
The first thing to do is to ensure that you speak to a qualified legal professional that specialises in family law. You will need to establish a position you are willing to accept in relation to assets you jointly own, custody of children, and what happens to the business you own and operate.
Even though your former partner may not own any shares or units in the business you operate, there still may be instances where your former partner may have a claim over the business as a part of the separation proceeds.
How to value a business during a divorce or separation
Valuing a business where one or both parties who own the company are going through a divorce is largely the same as valuing a company for a normal sale. These valuation methods include:
- Transaction and trading multiples approach
- Discounted cash flow
- Assessment of premium to Net Tangible Assets
The key difference is incorporating the potential impact of the divorce and separation on the business.
Contrary to traditional beliefs, the value of a business can change if one or both of the owners are going through a divorce. The main question to ask at this point is how involved are the owners in running and operating the business?
If the owner going through a divorce plays a critical role in the operations of the business, then the value could be impacted. There are a number of reasons for this:
- Going through a divorce is a very stressful process and this may mean that the owner is unable to focus on the business. This, in turn, could impact the profitability of the company over time.
- A divorce is costly, requiring the use of lawyers and experts. The owner may be reluctant to spend money on the business because they are worried that they may have to give money to their partner as part of the divorce settlement.
- The owner is unable to make considered and rational decisions in relation to the long-term viability of the company where there is a possibility that they might have to sell the company as a result of the divorce settlement.
- One party that is critical to the operation of the business may not be willing or available to provide a detailed handover of their role to the new owner which may impact the overall value of the business.
The impact of a divorce on the relative value of the company is hard to ascertain. However, if the company is forced to be sold as a result of the divorce settlement, an experienced corporate advisor will be able to manage the process so that the impact is minimised and the value achieved on sale is close to (or even exceeding) the desired level of the shareholders.
Do you need to sell a business if going through a divorce or separation?
This question is one that we are commonly asked. The answer again is that it depends. Often, the business is one of the main assets that a couple will own along with shares and the principal residence. Normally in this situation, the court will require a valuation of the business to determine the total asset pool before dividing the assets between each party.
If your business is considered to make up the majority of the total asset pool then it is likely that you may have to:
- Sell the company as a whole
- Give your former partner shares in the business
- Pay out your former partner in cash to the equivalent amount of the value of the shares they were entitled to
If the relationship is one where there is mutual respect and both parties can work together, then it might be beneficial to simply provide shares to your former partner instead of paying them out.
If the relationship is not good, then it is likely that having your former partner as a shareholder may be detrimental to the long-term success of the business and harm the company value over time. In this instance, we suggest providing them with a cash settlement is the best option.
The last decision is in relation to cash availability. If you have enough cash to pay out your former partner as part of the proceeds split to avoid handing over shares in the company then this might be your best option.
If, on the other hand, you do not have the cash to be able to pay out your former partner for their split of the business, these options will need to be considered:
- Obtain debt finance – either through a commercial loan, personal loan or asset finance.
- Sell all of the company – sell the entire company and split the proceeds of sale
- Sell part of the company – sell a portion of the company to private equity or another investor to fund the divorce settlement
Experienced corporate mergers and acquisitions advisors can walk you through each option and present a clear path forward.
How to sell a business during a divorce or separation
Selling a business where one or both of the parties is going through a divorce is largely the same process as when selling a company under normal circumstances. The major difference is when the two parties going through the divorce hold key positions in the company.
In this circumstance, it is critical that the relationship of the former partners is respectful and does not impact the normal day to day operation of the business. This means getting the highest price for the company with fewest material commitments to the vendor, post-sale.
Selling a business requires input from all key management shareholders, particularly if those shareholders are former partners. In order to achieve the best outcome from the sale, the former partners will need to work together and be respectful during the sale process. Both parties will need to ensure that:
- They perform their current roles and responsibilities for a period post the sale of the company to assist with the transition
- They attend meetings together with interested parties and potential purchasers of the company to answer questions about the business
- The company continues to operate in the same way, with minimal disruptions caused by separation or divorce
- While in the working environment, the parties are respectful to each other and all staff members
An experienced corporate advisor will assist in managing the entire sale process to provide a level of independence to the process and to ensure a successful result is achieved in the sale.
How to buy out a partner from a business during a separation
Buying out a former partner from a business can be a complicated process however there are a few simple steps which can make the process much easier.
Step 1 - Obtain a valuation
The first step in buying out your former partner is to obtain a valuation. This valuation should be completed by a qualified chartered accountant that has significant experience in conducting valuations.
The valuation should be based on generally accepted methodologies being discounted cash flow (Net Present Value), and a multiples approach using trading and transactions data from similar companies in the same industry or sector. Once the valuation has been performed, you will have a reasonable view of what the business is worth to give you a starting point in any negotiations.
Step 2 – Work out how you will fund the transaction
Depending upon the size of the business, you may need to obtain external funding to purchase the shares from your former partner. If you decide to fund the purchase using debt, then you will need to approach the bank with a proposal including what you are willing to provide as a guarantee for the loan and the cost of the debt.
If you are purchasing the shares using outside equity, then you will need to approach potential investors with an investor report or Information Memorandum to outline the investment offer.
Step 3 – Appoint an experienced transaction lawyer or advisor
Appoint an experienced transactions advisor or lawyer to assist with the negotiations and to help with getting funding for the acquisition. The advisor will be able to negotiate the terms of the purchase, including:
- Total consideration paid
- Payment terms (percentage paid upfront versus delayed)
- Any indemnities and warranties provided
The transaction may also require the shareholder's agreement to be amended if there is a change in control within the company structure.
Step 4 – Have a clear business plan post-purchase
Once the transaction is completed, set out a new business plan which takes into account the new shareholding structure. This plan could address issues such as recruiting people into roles to backfill the position held by the former partner, or simply outlining a new strategy and vision for the company under the new ownership structure.
The plan will give the business a new fresh approach and ensure all existing employees are clear on the long-term company vision. We recommend appointing an independent advisor to assist you through all of the above steps to ensure a successful outcome is achieved.
How to fund a buyout of a business during a divorce or separation
There are many options available to fund the buyout of a former partner who is also a shareholder in a company. These can be in the form of debt, equity or a combination of the two, known as mezzanine debt.
The options available include:
- Equity from the existing shareholders or directors – the existing shareholders purchase the shares of the selling partner who is forced to sell as a result of the divorce.
- Debt funding from a bank – the purchasing shareholder gets a loan which is unwritten via personal guarantee, the shares in the company or assets in the company.
- Equity funding from the third party – this can be from a private equity fund or individual investor who will become a new shareholder in the company.
- From a mezzanine fund – this is a mixture of debt and equity where the loan can convert to equity if certain performance hurdles are met.
Each funding option has its pros and cons and should be properly understood by the shareholders. We have outlined some of those issues in the section below:
Debt funding is debt borrowed to finance a business, usually from a financial institution.
- Positives: Cheaper than equity funding, and ensures 100% ownership of entitled shares.
- Negatives: Requires some sort of guarantee to secure finance and the debt needs to be paid back over time.
Private equity is the direct investment in a business by investors and equity funds.
- Positives: Allows a new investor to assist with the growth of the business without having to fund the purchase of shares from a former partner.
- Negatives: May have to give up control over some or all of the business decisions with new investors that may be unknown. Private equity tends to have short investment horizon so may need to exit the business or purchase their equity holding back in future.
Equity from existing shareholder base
Here, equity is sourced from existing shareholders, as opposed to outside investors.
- Positives: Ability to fund the purchase from existing shareholders is a simpler and easier process.
- Negatives: Requires the shareholders to fund the share purchase which may mean some shareholders get diluted to minority level or lose overall control of the company.
Mezzanine funding is a blend of debt and equity financing that carry higher interest rates.
- Positives: If the company performs poorly, then the debt will not convert to equity which means that the shareholders simply have a cheap debt obligation that they have to pay out over time.
- Negatives: If the value of the company increases considerably then you may not want the mezzanine debt to convert to equity as the shares forgone would be worth considerably more than the size of the debt – this could be considered very expensive debt.
For more information about selling a business in the event of divorce or separation, contact Nash Advisory. Our team can help you navigate the process for the best possible outcome.