As a business owner, you probably invested time, money, sweat, and tears into building your company. Your business can influence your entire life, so it is important to understand the impact of getting married on your separate property business. After marriage, ongoing efforts by either spouse into the business can be considered community contributions, meaning that the community is entitled to receive a share of any economic benefit that results from these post-marriage contributions to the separate property business.
If you have not taken measures to protect your business in advance of marriage and community efforts are used to increase its value, then the community may be entitled to a share of the business. Even entrepreneurs who founded their businesses before getting married or otherwise attempted to classify it as separate property may be required to divide ownership or the right to profits after a divorce.
This is a result of California’s community property laws. The state views the income and assets each spouse acquires from working during the marriage as community property and eligible for asset division, regardless of the source. If your business increased in value during the marriage, the community has likely earned a “community interest” in it, whether or not your spouse has played any direct role in its success. If you own a company that is considered separate property, it is in your best interest to understand how community interest may be determined and how it may impact your divorce settlement and company going forward.
The Importance of Valuing Community Interest in Businesses
Generally, assets deemed separate property are exluded from the division of property in a divorce. Even if these separate property assets appreciated, their status as separate property means that they are not included with the community property. For instance, an investment account that one spouse funded before getting married remains their sole property even if the value increases significantly, so long as they do not commingle it by making further investment purchases in that account with community assets.
Similarly, if an entrepreneur founds a business before marriage or uses separate assets to found one after marriage, it is considered separate property. However, when a separate property business increases in value during the marriage as a result of the efforts of one or both spouses or due to additional investment of community assets, the community is entitled to a share in the appreciation upon divorce. The increase in the business’ value will be apportioned between separate and community property from date of marriage to date of separation (or trial).
Approaches to Valuing Community Efforts in Separate Property Companies
California courts have developed two approaches to apportion the earnings and profits or increase of value of the business between separate and community property: Pereira and Van Camp. Pereira Analysis
If a company is considered “labor-intensive,” it is most often subject to Pereira analysis. In these companies, the majority of the increase in value is created by the time, skill, or efforts of the spouse during marriage and not outside market forces. Labor-intensive businesses rely on manual effort to succeed and include companies such as family restaurants and other small service industry businesses.
According to this method, the court first determines the value of the business at the time of marriage, which is then assigned a reasonable rate of return. This number is added to the principal provided by the entrepreneurial spouse.
Then the community interest in a separate property business is determined by subtracting that amount from the company’s current valuation. The residual is attributed in part to your spouse’s efforts and therefore is subject to asset division.
Van Camp Analysis
If a company’s success is determined by market forces or the business itself instead of your spouse’s efforts, the Van Camp analysis is typically used to determine the community interest. This is often used for larger companies that have made money due to intellectual property or the unique nature of their offerings, such as franchises with well-known names or products.
Under the Van Camp approach, courts determine the reasonable compensation for the efforts that the community contributed. This amount is mulplied by the number of years the couple was married, and the community expenses the couple paid are then subtracted. The remainder is the separate property interest of the business owner.
How to Determine the Best Method for Your Divorce
Both the Van Camp and the Pereira approaches may benefit business owners under the right circumstances. The Pereira approach generally favors the community interest in the business, and is most effective at achieving a fair division in smaller businesses, where one spouse’s efforts can significantly impact the company’s success. In contrast, the Van Camp approach is often best for large companies or those that succeeded primarily due to the investment of the entrepreneur’s sole assets.
However, there are exceptions to these circumstances. For instance, some separate property companies may experience significant growth over the course of a marriage in large part due to the non-owner spouse’s efforts. In this case, it may take careful analysis to determine whether Pereira or Van Camp accounting is more appropriate.
Discuss Your Concerns With Expert Divorce Attorneys
Determining community interest in a separate property business can significantly affect your company’s future. The best way to determine the most favorable approach is to consult a knowledgeable divorce attorney with experience in multifaceted high-net-worth divorces. At Flicker, Kerin, Kruger & Bissada LLP, our skilled attorneys are available to assist with even the most complex of divorce disputes. Our attorneys have years of experience representing and advising clients in a wide variety of financially complicated divisions, including valuing the community interest in companies like yours. Schedule your consultation to discuss your needs and explore how we can assist you with divorce and business valuation matters.