What Happens to a Medical Practice or Closely Held Business in a New Jersey Divorce?

For a physician, entrepreneur, partner or closely held business owner, divorce can affect much more than personal finances. It can raise questions about the value of the practice, ownership rights, cash flow, professional goodwill, business debt and the continued operation of the company. The concern I often hear is direct: “Can my spouse take part of my business?”

In most cases, the answer requires more nuance. A divorce does not ordinarily mean that a former spouse will become a voting partner in a medical practice or begin participating in daily business decisions. However, some or all of the value associated with the business may be considered in New Jersey’s equitable distribution process. Understanding the distinction between ownership, value and income is essential.

Is a Medical Practice or Business a Marital Asset?

A business interest acquired during the marriage may be subject to equitable distribution, even when only one spouse is listed as the owner. If the business was established before the marriage, the premarital interest may be exempt. However, some increase in value during the marriage may become an issue, depending upon the facts, the owner’s efforts and the source of the growth.

Relevant questions include:

• When was the business formed or acquired?
• How was the initial investment funded?
• Did marital funds support the business?
• Did either spouse work in or contribute to the company?
• Did the owner’s active efforts increase its value?
• Were business and personal expenses kept separate?
• Was an ownership interest acquired or expanded during the marriage?
• Is there a prenuptial or postnuptial agreement?
• Are there shareholder, partnership or buy-sell agreements?

New Jersey’s equitable distribution statute directs courts to consider numerous factors, including the length of the marriage, the property brought to the marriage, the marital standard of living, the parties’ economic circumstances and their contributions to the acquisition and preservation of marital property.

Valuing a Professional Practice Is Not the Same as Reading a Bank Statement

The amount held in a practice’s operating account is not necessarily the value of the business. A valuation professional may examine:

• Historical revenue and profitability
• Owner compensation
• Accounts receivable
• Equipment and other tangible assets
• Business liabilities
• Recurring patient or customer relationships
• Referral sources
• Staffing and overhead
• Market conditions
• Nonrecurring expenses
• Related-party transactions
• Ownership restrictions
• Buy-sell agreements
• Goodwill

Valuation generally involves both financial analysis and professional judgment. Different methodologies can produce significantly different conclusions, particularly when a practice depends heavily on the reputation, licensure or continued labor of one individual.

The Difference Between Enterprise and Personal Goodwill

Goodwill is often one of the most disputed components of a professional-practice valuation. Enterprise goodwill is connected to the business itself. It may arise from an established workforce, recognizable trade name, location, systems, referral network or recurring customer base. Personal goodwill is connected more closely to the individual owner’s reputation, relationships, skill or continued presence.

Consider two medical practices with identical revenue. One has multiple physicians, established systems and patients who identify primarily with the practice. The other depends almost entirely on one doctor’s personal reputation and relationships. Those businesses may not have the same transferable value. The distinction is highly fact-sensitive and can materially affect a valuation.

Normalizing Income and Expenses

Closely held businesses frequently pay expenses that a valuation expert may need to examine or adjust. These can include:

• Vehicles
• Travel
• Insurance
• Family-member payroll
• Retirement contributions
• Personal expenses paid through the business
• Above-market or below-market compensation
• One-time purchases
• Nonrecurring legal or consulting expenses
• Discretionary distributions

This process is sometimes referred to as normalizing the financial statements. Its purpose is to estimate the company’s actual economic performance rather than simply accepting every accounting entry at face value. Normalization can affect both business value and the income available for support.

Business Value and Income Are Different Questions

A business can be valuable while producing limited current cash flow. It can also generate significant income while having relatively little transferable value. Divorce counsel should distinguish among:

1. The value of the ownership interest for equitable distribution;
2. The owner’s recurring income for alimony and child support; and
3. The business’s working capital and operational needs.

Failing to separate these questions can produce unrealistic settlement demands or agreements that undermine the company’s ability to operate. It may also create concerns about double counting when the same income stream is used both to establish the value of the business and to determine support.

Will the Business Have to Be Sold?

A forced sale is not the only way to address a business interest in divorce. Frequently, the operating spouse retains the business while the other spouse receives value through:

• Other marital assets
• A structured buyout
• Payments over time
• A distributive award
• Retirement assets
• Real estate equity
• A combination of property and cash

The appropriate structure depends on liquidity, taxes, financing, risk and the overall marital estate. A settlement that looks equal on paper may be unworkable if it requires the business owner to remove too much cash from the company or assume debt the business cannot support.

Protecting Business Operations During the Divorce

Litigation involving a business may require extensive financial disclosure, but disclosure should be handled carefully. Sensitive information can include:

• Patient or customer records
• Proprietary methods
• Employee compensation
• Partnership agreements
• Confidential contracts
• Pricing information
• Trade secrets
• Strategic plans

Legal counsel can evaluate whether confidentiality agreements, protective provisions or narrowly tailored discovery requests are appropriate. The owner should also avoid making unusual financial changes after divorce becomes likely. Sudden reductions in salary, large purchases, unexplained distributions or changes in bookkeeping may create suspicion, even when there is a legitimate business explanation. Maintaining consistent records and ordinary business practices is often the best protection.

Documents to Gather Early

Doctors and business owners considering divorce should begin organizing:

• Personal and business tax returns
• Profit-and-loss statements
• Balance sheets
• General ledgers
• Bank and credit-card statements
• Payroll records
• Ownership documents
• Partnership or shareholder agreements
• Buy-sell agreements
• Loan documents
• Accounts-receivable reports
• Compensation records
• Business appraisals
• Prenuptial or postnuptial agreements

Early preparation allows counsel and financial experts to identify issues before they become emergencies.

A Coordinated Approach to Complex Divorce

A business-owner divorce may require coordination among divorce counsel, forensic accountants, valuation professionals, tax advisers and estate-planning attorneys. The purpose of the team is not to make the divorce more contentious. It is to ensure that decisions are based on reliable information and that the final agreement is financially workable.

At Adinolfi, Roberto & Burick, P.A., we represent physicians, executives, professionals, entrepreneurs and their spouses in New Jersey divorce matters involving professional practices, closely held companies, complex income and substantial marital estates. To discuss the valuation or protection of a business interest in a New Jersey divorce, contact our office to schedule a confidential consultation.