Protect entrepreneur clients

Colleen was on top of the world.

A chartered accountant, she’d always wanted her own business. So four years ago, Colleen (not her real name) and her husband incorporated an oil-and-gas company in Alberta. It made $2 million in revenue its first year. She ran the finances; he handled operations.

They had a daughter a year later. The firm grew to 13 employees. Sales were brisk. Things were going well.

Until last October, when Colleen’s husband left her—but not the company.

Now, she has the unenviable task of dividing a business she no longer wants with a man she barely speaks to.

“I’m still doing the accounting, which is awkward because I don’t want to deal with him,” she says. “Yet he’s been trying to push me out. I won’t leave because I want a handle on things.”

Colleen’s in a good position, says her advisor, Wendy Olson-Brodeur, CFP, FDS, founder of The Financial Divorce Specialist Inc. in Calgary. Colleen’s role ensures she has a thorough understanding of the business in which she’s a partner; her skills as an accountant ensure she can start a practice or find a job once the dust settles.

Owning a business in common makes divorce, never easy, even harder. Colleen wants her ex to buy her out, but he’s low-balling. She paid out-of-pocket for a third-party business valuation, because he refused to allow it as a corporate expense.

Now, Colleen wants to sell the business and split the proceeds, but her ex needs to agree. Since they never drew up a shareholder agreement, they have no documentation on which to fall back, and the process is at a standstill.

Top factors

Colleen is part of a growing contingent. In Canada, women are choosing entrepreneurship at a faster rate than men, and almost half of small businesses have at least one female owner. These women tend to be more affluent than their salaried peers, and chances are you’ll encounter them among your clientele. The fastest growing segment is women over age 55: entrepreneurship’s attractive now that their children are grown, or they’ve been downsized out of a corporate job.

So, even if they’re not currently part of your book, they likely soon will be. On the other end of the spectrum, more women are starting businesses before they marry, adds Natalie Jamison, investment advisor at RBC Dominion Securities in Oakville, Ont.

So how can you protect clients and their businesses in case of marital breakdown?

Olson-Brodeur recommends entrepreneurs plan for worst-case scenarios, especially when going into business with a spouse. “I ask, ‘Is it your passion or his? If you divorce, will you still want to be in business with each other?’”

Clients must then put those answers into a shareholder agreement with buy-sell provisions: valuation methods, when to sell, and to whom the shares can be sold (e.g. only between spouses, children or siblings; or to outside investors).

The business’s worth is often the biggest sticking point—hence why Colleen used a third party to assess hers. To avoid shareholder disagreements, “we recommend owners have the business valued every two to three years,” says Jamison. Another important time is when an owner gets married. As with other assets, the spouse is entitled to any value increase following the marriage date, whether or not he is a shareholder. So owners need to know the baseline.

Read: Knowledge checklist for passive partners

A prenuptial or cohabitation agreement can also protect the business, but it has to be fair, says Abby Kassar, vice-president of high net-worth planning at RBC Wealth Management in Toronto.

“If it’s not, the courts may not agree to it. If you’re saying the business is off-limits, ensure [your client’s] spouse gets independent legal advice.”

What’s hers is hers

How the company’s structured is key to ensuring an owner maintains control.

Olson-Brodeur has seen several clients lose companies due to divorce, so she’s built her practice carefully. “I’m incorporated, and the sole shareholder,” she says.

Her husband’s name doesn’t appear anywhere in the firm’s articles; even though she’s left him the company in her will, she can change that anytime.

“If he were my bookkeeper, or otherwise involved, the most I’d give him is 49%,” she adds. “If it’s truly your business,” she tells clients, “keep majority ownership.”

Angela Galer-Grist, CFP, FMA, BA, CPCA, an investment advisor at BMO Nesbitt Burns, agrees. “It’s important for someone to have majority control,” she says; otherwise, you can have a stalemate.

Your client could reduce her taxes by naming her husband a shareholder, since the two can income-split, and his capital gains exemption could be used to shelter future gains in the business. Those benefits could outweigh any potential downfalls later.

“But if she does issue shares, she should maintain voting rights,” Kassar warns.

If there are shareholders besides the spouses, says Galer-Grist, the agreement should state “that if there is a divorce, [the husband] would receive value for his shares, but he wouldn’t become an active shareholder if he hadn’t been up to that point.”

Where possible, the business should be incorporated, she adds, because “it technically separates personal assets from those of the corporation. But a financial institution will likely ask an owner to pledge personal assets anyway.”

And that is where they must tread carefully.

If a client uses a personal asset, such as a line of credit registered against her residence, for business purposes, it subjects the company to split upon separation or divorce. “If the business needs a loan, find a way to get it that’s not tied to personal assets that will be subject to matrimonial split,” says Jamison.

Read: Redoing the will

She acknowledges this can be difficult in a company’s infancy, because the owner doesn’t have the requisite three years of financial data.

If a client gets an inheritance or gift, she can put it toward her business, but such funds are usually excluded from the pool divided upon divorce. Comingling them changes that if the firm wasn’t initially walled off via a prenuptial agreement.

However, says Kassar, if a client in Ontario uses her inheritance to start a business after she marries, she’s using property that’s excluded from division upon divorce. Further, if her benefactor’s will indicates growth in the inheritance is exempt from matrimonial property, that also protects the company.

Another reason to avoid co-mingling assets, says Jamison, is to protect marital harmony.

“If the business isn’t doing well, and it’s tied to the family home [via collateral for a loan], that leads to stress within the couple, which itself could lead to divorce.”

Fate of the business

But structure can only prevent so much. Once divorce occurs, dividing things can get messy.

Sometimes, a business can be easily halved. “If two accountants want to separate, they could split their firm and continue practising,” says Kassar. She suggests including a non-compete clause to ensure spouses don’t poach each other’s clients.

But it’s usually not that simple. “With divorce or separation, you need cash to do a buyout, so [as soon as clients start a business] we tell them to set aside a portion of their earnings,” says Jamison. Owners, though, often push all cash into operations, and so don’t have enough when the time comes.

One fix is for the departing shareholder to borrow money to fund the buyout, but he may not qualify for a large-enough loan—especially if the business’s value has ballooned since inception.

And since the company is usually the owner’s biggest asset, there’s little left for collateral. Without a shareholder agreement, as in Colleen’s case, the spouse can simply refuse to take out a loan.

“That leaves them running the business together, and some can manage,” says Kassar. If they choose that route, “It’s highly recommended they have a board of directors that can advise them in making decisions.”

In the case of an acrimonious divorce, though, there’s usually a desire to cut and run. So the last option, which Colleen has chosen, is the most common: selling the business and splitting the proceeds.

“They have a better chance at getting the proceeds and starting something else separately, as opposed to seeing it decrease in value” due to infighting, says Kassar.

And finding a buyer can be hard, “especially if one of the parties was the key person to generating that revenue, and they’re leaving. It can change the valuation quite a bit,” says Jamison.

When that valuation does occur, make sure both parties agree on timing.

“Spouses don’t always agree on the separation date,” says Galer-Grist, yet that’s when all asset valuations are effective in Ontario*. This affects the business, real estate, investment portfolios, and even art and heirlooms.

In Alberta, says Olson-Brodeur, if a divorce case gets drawn out, values can change.

“Say I separate and [on that day] I’m worth $1 million; each of us is entitled to $500,000. Then it’s 2008 and the market crashes,” she says.

“If my portfolio is now worth $500,000, the courts won’t necessarily leave my husband with nothing.” Instead, the courts may look at the new value and award each $250,000 instead.

More concerning, Olson-Brodeur’s seen an owner take advantage of that lag time to siphon away value and hide income.

All the more reason to have written, airtight documentation that prescribes what to do in case of divorce.

Colleen knows that all too well. But she’s not sorry for the trouble she’s taking, and offers this advice to other divorcées.

“Don’t let emotions make your decisions. Don’t say, ‘I’m going to walk away, because it’s just stuff,’ ” she says.

“After the emotions are gone, you’ll regret not fighting for what’s rightfully yours.”

*The original version of this article did not specify that the separation date rule applies in Ontario. The rule varies from province to province; in Alberta, for instance, if a case goes to trial, the value of the assets are set the date of trial, not the date of separation. Return to the corrected sentence.

Melissa Shin

Melissa is the editorial director of Advisor.ca and leads Newcom Media Inc.’s group of financial publications. She has been with the team since 2011 and been recognized by PMAC and CFA Society Toronto for her reporting. Reach her at mshin@newcom.ca. You may also call or text 416-847-8038 to provide a confidential tip.