WHEN Gary Peterson wedded in 1999, he thought he was marrying a lifelong partner. So much so that Peterson made her an owner of a consulting business he started three years later.
But then the unthinkable happened. His wife filed for divorce, setting off a 1 1/2 -year legal battle. Because he lacked a prenuptial agreement, Peterson had to buy his wife out of her share of the business, a San Diego market research firm called Gap Intelligence.
“I was 27 when we got married,” Peterson, 34, said. “We were young. We were in love. We didn’t think about those things.”
Prenuptial agreements, experts agree, are the best way to prevent a small business from becoming part of a messy divorce. Properly crafted, they will protect a company from being split up or loaded with debt used to buy out the other spouse. This is especially true in California, where community property laws dictate that everything acquired during a marriage belongs to both spouses no matter who did the work.
“A prenuptial agreement is one of the best things people can do for themselves,” said Ben Martin, an attorney who advises entrepreneurs at the Small Business Development Center at Loyola Marymount University, which offers free counseling.
But what if the business is created after marriage, as was the case with Peterson? Sandra Morris, a San Diego family law attorney, says a postnuptial is an option, though a more complicated one.
The courts assume that a husband and wife have a duty to protect each other’s financial interest.
“If you get me to sign away my rights, the courts will look askance at that,” Morris said. “The courts will look to see if the agreement was signed under duress of any kind. They will want to know if both spouses understood what they were signing. If both sides go into an unfair agreement with eyes wide-open, the court can still uphold that agreement. But it’s a much tougher burden of proof.”
A postnuptial must be as clear as possible, Martin said.
“You have to make sure what you write down is idiot-proof,” he said. “Because you’re not going to be judged by what you meant. You’re going to be judged by someone else’s interpretation, the judge’s.”
Peterson, however, had neither type of agreement when his wife filed for divorce in October 2004. So he hired an attorney, who told him to get his books in order. A valuator, called a forensic accountant, appointed by the court would determine how much his business was worth -- half of which belonged to his wife.
In some California counties, such as San Diego, the court appoints a valuator. But in other counties, such as Los Angeles, each side hires its own and presents its competing valuations to the court, which then decides.
Ginita Wall, a forensic accountant in San Diego, tells business owners to collect five years’ worth of records. Review them, make sure they’re accurate and update those that aren’t. Write off uncollectable debts and obsolete equipment. At the same time, don’t hide anything. Forensic accountants will find any hidden assets.
Wall recalled a case in which a man took the company’s surplus cash and purchased artwork, with which he decorated his office. The court-appointed valuator didn’t recognize the artwork. But Wall found it by combing through the invoices and canceled checks. In another case, a man bought an expensive motorcycle from Escondido Cycling but entered the item in the ledger as a business expense to “Escondido Recycling.” Wall found it using the same investigative methods.
Having good, clean records helps in more ways than one.
“When there’s an argument, it’s not a matter of truth,” Martin said. “It’s what’s best documented that typically wins.”
For instance, the person whose name is on the business license is not necessarily the person who owns the business.
“Your name has to be on the stock certificate in the log of stockholders,” Martin said. “With an LLC [limited liability company], it has to be on the operating agreement and the ownership certificate. If you think you own the business, make sure your name is on all of these documents.”
Once a divorce has been filed and a value established for the business, what’s next?
“Go to counseling,” said Morris, who has represented divorcing clients for 37 years. “Divorce is second only to the death of a loved one in terms of the pain one suffers. People’s emotions are engaged. They don’t think clearly. They can do things that they might regret later. And that can be destructive to the business.”
“For me, the business was my baby,” Peterson said. “For her, it was her meal ticket. And we were both going to fight tooth and nail for it.”
Peterson’s divorce dragged on for 18 months and cost him $22,000, far more than if the matter had been quickly settled. The court ended up awarding her half the business, but at a value that was half the amount of his first settlement offer and less than one-third of his second offer.
“In the end, it’s very wise to settle,” said James A. Hennenhoefer, a Vista, Calif., attorney and president-elect of the American Academy of Matrimonial Lawyers.
Otherwise, the value could be a “crapshoot” for either side, Hennenhoefer said.
In Peterson’s case, the court-appointed valuator gave a low estimate of his business.
“The business was young, unstable and it relied almost entirely on me to make it work,” he said.
Even so, Peterson feverishly poured all of his energy into his fledgling business as his divorce marched on. His work paid off; Gap Intelligence quadrupled in revenue by the time his case went to court.
But the company was valued at the time his wife filed for divorce, when it was not even a year old.
“I was very lucky,” he said. “We agreed on the date of separation. Neither of us knew the ramifications of that. Had she known, she might have tried to set a later date.”
Peterson was lucky in another respect. His wife did not want to divide the business and take half of his clients. Not that the judge would have allowed her to do that. In general, a business is worth more if it’s intact, and the court is interested in preserving a couple’s assets.
Wall worked on a case in which the spouses owned a flower growing business.
“She got the roses, and he got the rest,” Wall said. “That didn’t work because she didn’t know everything she needed to know to run the business. She ended up getting squeezed out.”