FOUR WAYS TO PROTECT YOUR BUSINESS IN CASE OF DIVORCE

While most entrepreneurs don't want to think about divorce, matrimonial attorney, WILLIAM J. LEININGER, offers this advice: "Face the possibility of divorce from the first day you start your business. After all, only half of all marriages survive." Know if you're operating in a community property state, which views both spouses as equal owners of all marital property, or an equitable-distribution state, which considers factors like the length of marriage and the spouse's earning power and participation in building the business when determining a settlement. According to Mr. Leininger, New York, New Jersey and Florida are all equitable distribution States. Mr. Leininger suggests the following advice:

Safeguard your assets: It's crucial that you take steps to guard your assets, starting the day you put the key in the door.

First, draft a legal buy-sell agreement. Such agreements outline the terms and conditions under which one partner will agree to sell back part of the business. Mr. Leininger stressed that while these tools are used extensively for estate-planning purposes, they can also serve as a defensive tool in case of divorce.

If you operate a partnership, you can include a provision in your partnership agreement called a restriction of transfer, which states that there can be no transfer of ownership without the partners' approval. In this way, if the court orders a transfer of ownership to your spouse, your partners will bail you out and you won't lose all your interest in the business.

Create a good-will pact: A prenuptial or post-nuptial agreement is an important weapon in spousal warfare. This agreement, which can be drawn up by your matrimonial lawyer either before or during the marriage, can be as broad as the parties wish. It can spell out how business assets should be divvied up, overriding community property laws. And it can be used to ensure that the laws of the state where the couple were married will govern in the event of a divorce, no matter where they reside at the time of the breakup. While such documents are common in Hollywood, only 20% of the owners of family-operated businesses have them, according to consulting firm Arthur Andersen.

The law for pre-nuptial and post-nuptial agreements varies by state, and they must meet basic standards to hold up in court. Judges want to make sure each party completely discloses the value of his or her personal assets, liabilities and sources of income. They also want the agreement to be fair and not impoverish either party, stressed Mr. Leininger.

Avoid common mistakes: The last thing you want to have to do is sell your business in order to settle the score with your disgruntled spouse. So keep a line of credit at hand to cover 6 to 10 months of business operating expenses to keep your business from becoming cash-strapped during the proceedings. The cash should also come in handy when it's time to pay Uncle Sam. Although transfers of money or assets in a divorce settlement are not generally taxable if "incidental to a divorce", you may be hit with capital-gains taxes if you sell the stock you receive.

Also be sure to hire a professional to value your business. Hire a local business appraiser who is experienced in your line of work. He or she will obtain the business' adjusted book value (its assets including depreciation minus its liabilities) by using a variety of methods. While this can cost $2,000 to $6,000, you'll get a realistic evaluation that the court should approve. Mr. Leininger stresses that your matrimonial attorney should have this appraisal performed since it may be considered "attorney work product" and thus, be privileged under certain circumstances.

And think carefully about your compensation scheme. "If you don't pay yourself a fair wage and instead plow everything back into the business, your spouse might claim that he or she is entitled to more money because you kept pumping money back into the business that should have gone to the household," says Leininger.

Control the damage: Even if you find yourself facing divorce without a plan, you can still avert disaster. One smart strategy is to use a promissory note to buy out a spouse's interest in a business. As its name implies, it is a promise to make future payments, and it specifies the amount needed to equalize a divorce settlement. The IOU allows an entrepreneur to pay the spouse on an installment plan and deduct all interest payments as long as he or she continues to run the business.

Above all, do not lose track of the proprietary information you release during the divorce proceedings. Says Leininger: "Keep a trail of any sensitive documents like tax returns and contracts that you give your spouse and his or her lawyers. Get a protective order from the court that prohibits them from disclosing proprietary information like client or supplier lists." That's because a vengeful spouse can fork over trade secrets to your competitor and destroy you, Mr. Leininger said.

Keep in mind, the love song can quickly turn into a battle cry!