California is a community property state. Therefore, all property and businesses you own while married are subject to property distribution during a divorce. Your spouse may be entitled to a share of your professional practice, even if they did not have anything to do with its establishment or operation. Contact us at Los Angeles Divorce Lawyer to kickstart the process of protecting your professional practice during a divorce.
Discovery in a divorce is the process where lawyers identify the marital and personal assets each party has. Discovery happens before the divorce trial, right after you file for divorce.
During the discovery process, you and your spouse must disclose material facts and documentation about your assets and liabilities. Your practice is one of the assets that will be considered during the discovery process.
You may have to present the following:
- Information about ownership and operation. You must answer questions such as what share of the business does your spouse own? Does your spouse participate in the running of the business?
- Information about the financial standing of the professional practice, such as its value, profits, and liabilities
- Details about the assets you own in your practice include machinery, furniture, and cash.
- The nature and history of the practice from its creation
- The goodwill and intangible value of the business
During the discovery process, avoid concealing information about your practice. Hiding or attempting to hide assets in a divorce is the fastest way to lose more and be held in contempt of court or be charged with fraud.
If you are concerned about the financial well-being of your practice after the divorce, communicate with your attorney. Express your goals and what you would like to happen to your practice when the divorce is finalized.
Such honesty gives your attorney a better view of what’s at stake and helps them develop the best strategy to protect your professional practice.
Valuation of Professional Practices in California Divorce Cases
The valuation process lets you understand your practice's worth in the marital estate. In California divorce cases, the value of your professional practice varies depending on the following:
- The assets and liabilities, including cash, books, equipment, furniture, supplies, and accounts
- Enterprise and personal goodwill
- The history and nature of your professional practice
- The economic outlook of the industry in which the practice operates
- The financial capacity of the business
- The earning potential of the business
- The market value of other businesses in the same line of operation
In most divorce cases, the practicing professional is more likely to underestimate the value of their business, while their spouse overestimates it. Due to these disagreements in how you and your spouse value the practice, you must involve a third-party accountant or appraiser to determine the value of your business based on a comprehensive assessment.
Goodwill for a business refers to the public's continued patronage of a business. It includes intangible assets such as:
- A regular customer base
- Your reputation
- The length of time you've been in operation
- The likelihood that your business will continue as it has in the past
- The business owner’s age
Several methods help determine the goodwill a professional practice has:
- The excess earnings method compares you to an employee with similar experience and expertise and the practice's performance to determine the goodwill valuation.
- The Foster method is also used to determine your practice's goodwill. This method relies on a comparable salary and the practice's financial data to determine the business's past and potential future performance.
Note: While goodwill valuation can determine the final value of your practice, the court stipulates that the goodwill before the marriage and after the separation does not factor in the business valuation. Therefore, your spouse cannot use earnings or progress made after separation to claim goodwill related to community assets.
Community Property and Professional Practices in California
In California, assets and liabilities acquired during a marriage are community property. That is, it belongs equally to both spouses. Community property includes:
- Anything acquired during the marriage and before the separation
- Anything bought with income earned during the marriage
- Debt acquired during the marriage and before the separation
Gifts and inheritances to one spouse are separate property, as is student debt, where the skills gained are not used to benefit the community (your spouse and children).
Assets owned by the parties can be part separate and part community. Separate property was acquired before or after the marriage or received as gifts or inheritance. When a property is both separate and community, it is considered commingled.
For example, it is considered separate property if you started a professional practice before marriage. However, the value gained during the marriage is considered community property, regardless of your spouse’s contribution to the business.
When divorcing, the court divides your community property equally. Therefore, if your community property is worth $1,000,000, each party gets $500,000 after the split. This split doesn't necessarily mean splitting everything in half.
For example, one party could get the house worth $200,000 along with the mortgage, while the other party gets the $100,000 business but does not carry the mortgage burden.
If you inherited the practice from your family, it could be considered a community or separate property. If you kept the business separate from your marriage, it is considered separate property. Therefore, your spouse has no stake in the business; neither are they entitled to splitting anything from it.
However, if you included your spouse in the business, it is considered community property. In this case, your spouse is entitled to half the assets and liabilities of the professional practice.
Determining Ownership of Professional Practices in a Divorce
Professional practices differ from other types of business. When you're the only person with the expertise, education, skill, and licensing to operate the practice, it's fairer when you have control of the business.
In divorce cases that include professional practice, the court will consider whether you are the reason the practice exists. For example, a dental practice or a therapist requires education and skill to run that business.
Therefore, unless your spouse has the required qualifications, you're more likely to have control of the business.
Using Marital Settlement Agreement to Protect Your Professional Practice
Marital Settlement Agreements in California document the agreement you and your spouse make regarding asset and liability distribution, spousal support, and child custody and support.
These agreements are an excellent way for couples to control their rights and responsibilities, including ownership and control of professional practices.
Most uncontested divorces usually include a marital settlement agreement. You develop this agreement with the help of an attorney or a mediator to ensure that you draft an agreement that meets all the legal requirements of equitable and fair distribution of marital property.
In the marital settlement agreement, you can retain ownership and control of your professional practice in several ways:
- You can buy out your spouse. When buying your spouse out of business, you may have to pay more than half the current value of the practice since it will continue generating revenue after the divorce.
- You can exchange another asset of similar value for the practice; for example, you can take the practice while your spouse maintains ownership of the house.
- You can maintain co-ownership of the practice.
- You can agree to pay your spouse a certain amount every month
The worst-case scenario would be selling the practice and sharing the proceeds 50-50.
When done correctly, property settlement agreements save you from leaving the property division process up to the court. It allows you and your spouse to discuss what property each person would like to take from the divorce.
Therefore, you can choose to forego some of the property or assets from your community assets to protect your practice. When developing the settlement agreement, you must compile a list of the assets and liabilities owned separately, which is part of the community. The list will guide you (and the experts you work with) in equitably dividing these assets and liabilities.
Property settlement agreements are binding for you and your spouse. Failing to adhere to the agreed-upon precepts could result in severe penalties and legal action.
How Pre- and Post-Nuptial Agreements Can Help
Prenuptial and postnuptial agreements are a great step in protecting your professional practice should you and your spouse divorce. Well-drafted agreements will stand up in court and protect your interests concerning your practice. They also take precedence over community property laws in California. A well-drafted prenuptial agreement:
- Is in writing and signed by you and your spouse
- The signatory parties must be capable of consenting to the agreement's contents. The court often considers the date you signed the agreement and the date of the marriage. Agreements signed too close to the wedding date could be deemed coercive, therefore, invalid.
- The agreements must be fair (courts often overrule prenuptial and postnuptial agreements that favor only one spouse.)
- The signing parties must have an attorney review the agreement before they sign it to ensure all their interests are represented.
- The agreements should not contain any provisions prohibited by law, for example, provisions for child support of unborn children.
- Establish the value of the business at the time of signing the agreement. If it's a prenuptial agreement, it states the value of the business before the marriage. This makes it easier to determine the value acquired during the marriage, making division easier. On the other hand, a postnuptial agreement establishes the value of the business founded or established during a marriage.
- Specify the ownership rights or business interests each spouse has in the business. Under California law, businesses in a marriage belong equally to both parties. However, with a prenuptial or postnuptial agreement, you and your spouse can determine who will be the primary owner and what assets each spouse is entitled to in case of the dissolution of the marriage.
- Determine how an increase in the value of a business will be divided in case of a divorce. Since most businesses grow in value after marriage, this value is considered community property. A prenuptial or postnuptial agreement details each spouse’s rights to this value.
- Set parameters for the valuation of a business. Business valuation is a common source of conflict in divorces. The spouse who spends most time in the business undervalues it while another overvalues it. These agreements determine the methods both parties will use to determine the value of the business.
- Address how premarital and post-marital debt will be addressed, including business and personal debt
- Determines how you and your partner will deal with taxes from the business or your incomes
Note: when signing a prenuptial or postnuptial agreement, you and your partner must fully disclose your assets and liabilities. Failing to do so will invalidate the agreement.
Mistakes to Avoid When a Divorce Involves a Professional Practice
Amidst the anger, frustration, and overwhelming emotions of a divorce, most people make catastrophic mistakes to protect their interests. When a professional practice is one of the things you want to protect, you should be wary of these common mistakes.
Misrepresenting the Value of Your Practice
Dishonesty in the disclosure process is the fastest way to lose in a divorce. Lying to your attorney, the court, or spouse on material facts about your assets or liabilities can land you in serious trouble, including the risk of losing your professional practice.
Do not attempt to cook your books to present your practice as an unprofitable entity. You should also disclose all the debts and assets of the practice.
Instead, discuss your interest in maintaining ownership of the practice with your attorney. Your attorney can then work with your spouse's attorney to negotiate a property distribution agreement that accommodates your interests.
Similarly, if you need more clarification about what your practice is worth, consult a professional appraiser to evaluate the value of your professional practice. Working with a reputable accountant or business valuation firm will help you avoid common valuation mistakes that business owners make.
Not Hiring an Attorney
Divorces are complex enough without the additional burden of professional practice. Failing to work with an attorney means you miss a lot of insight that you could have gained from a qualified family law attorney.
An attorney guides you through the property division process, helping you avoid the common pitfalls people encounter.
Not Having a Prenuptial or Postnuptial Agreement
Prenuptial and postnuptial agreements have common myths, including encouraging one partner to financially take advantage of the other partner.
However, when well-executed, following the legal requirements, a prenuptial or postnuptial agreement provides the best way to protect your professional practice or business during a divorce.
The best thing about postnuptial agreements is that you can sign them regardless of the length of your marriage. For example, if you start a practice and would like to retain ownership should the marriage fail, a postnuptial agreement will include the provision for it.
While signing any of these agreements, ensure that both parties agree voluntarily to the clauses in the agreements. Without their voluntary agreement, the court could rule the agreement invalid and divide your property and practice based on property distribution laws.
Failing to Identify Separate Property Properly
Since it's a community property state, one of the first things you do during an asset distribution procedure is to identify the separate and community property within your marriage. Mistakes in categorizing these assets could impact the asset distribution process.
For example, if you categorize your practice as community property when it is, in fact, separate property, you risk distributing what is rightfully yours.
Letting Emotions Lead You
You’ve spent years building your professional practice. Now, the looming divorce is putting all your years of hard work at risk. For most people, the next step is trying as fast as possible to deprive their spouse of access to their business.
You may end up making irrational decisions, such as cooking your books or trying to redirect funds from the business.
These mistakes are costly, especially when the court involves a forensic expert to look through your business.
Instead, contact a reliable Los Angeles Divorce Attorney to start preparing for the legal ways in which you can protect your business interests during the divorce.
Insisting on a Court Trial
Divorce trials are long, expensive, and emotionally draining. Most divorces hardly end up in court as parties often can settle their differences through mediation.
Insisting on a court trial, especially when trying to protect your professional practice, could easily backfire. Instead, look for ways you and your spouse can compromise on different issues to reach a favorable agreement for all parties.
Therefore, instead of trying to retain the house, the cars, and your practice, let your spouse have another asset that allows you to remain the owner of your professional practice.
Find a Los Angeles Divorce Lawyer Near Me
The complexity of divorces where one party wants to protect their professional practice necessitates hiring an experienced divorce lawyer. The lawyer is familiar with the common pitfalls and laws around the treatment of professional practices in California, therefore, uniquely positioned to help you. We at Los Angeles Divorce Lawyer will help you understand your rights and responsibilities in a divorce, including your options when your professional practice is at stake. Book your free consultation at 310-695-5212 today.