Why prenups matter for business owners

Nerre: Welcome back to Building More Than Business. I'm Nerre Shuriah, the National Director of Wealth Content and Knowledge. I'm also a certified business exit consultant and certified M&A advisor.

Ann: And I'm Ann Lucchesi, a certified financial planner, a certified equity professional and a Senior Director here at First Citizens Wealth.

Nerre: So our topic for today's episode gets to really the core of why we do this podcast and a lot of the complexity in our clients' planning. And that is three things: marriage, money and business ownership, and how do they all intertwine?

As we learned from our survey that we did last fall, a lot of our business owners commingle their personal and business finances—as high as like 74%. So when you add marriage to that mix, you've really got a brew of complexity there.

So there are some unique challenges that we want to address, but we're going to do this episode a little bit differently than how we normally do it. I'm a big proponent of storytelling, so instead of just giving you the solutions or answers, we're going to put it in a real-world context. What's the type of fact pattern or situation that you would normally see, and then what are some of the issues you need to think about or how to address it?

All right, so let's get to it. Our first scenario is we've got a young founder launching a company and engaged to be married. Let's talk, Ann. What are some of the issues that this person's facing? And let me just tell you up front, he's got inconsistent income, personal guarantees—regardless of the choice of entity that he chose for his business—and there's some question about whether or not the future spouse will provide some financial stability.

Ann: Yeah, well he's got a lot to think about. I think starting with the cash flow uncertainty. I think that can create an awful lot of stress, number one, and so planning around that so you have the constant liquidity. That might come from your spouse, but it needs to be a conversation about what kind of stressors that's going to put in your marriage.

And then thinking about those business liabilities. He needs to talk to this future spouse about what she's getting into. It's not just an asset, it's an asset with some liabilities, and they need to think about that.

Then I always think, go forward in time. Things are going well. What's going to happen when you start getting some money out of that business? Have you discussed what you’re going to do with it? Because I can guarantee the business owner’s like, I'm going to double down, I'm doing great, let's just keep growing. That might not be what his partner's thinking should happen.

I run into the problem all the time of a founder like this being worth a whole lot on paper. They might be worth $50 million, but they don't even have enough money for a down payment for a house, which their spouse would really, really like to have. And then I think finally there becomes this reliance on the spouse's income for that continuity and security, and that creates its own issues within a marriage.

Nerre: Yeah, absolutely. Business owners tend to be very optimistic. They have an emotional attachment or identity attachment to the business. The supporting spouse could be making a lot of sacrifices that go unacknowledged. That creates expectations for the future that maybe the founder doesn't see because they think, well, I put my blood, sweat and tears into this business. You stayed at home—not realizing that facilitates your ability to put your effort into the business. So taking the time to align what people are expecting to happen in a variety of scenarios is really key to preventing some of these situations.

And lastly, communication, so important. I think we talk about it flippantly, like talk this through, talk this through, but it's really hard. It's hard to have those discussions. That's why people avoid it, but they're really key to a solid foundation for your marriage.

So I want to move on to our second story, and this one is really common. We've got a founder who almost all their wealth is tied up in the business, so incredibly illiquid, and they're divorcing without a prenuptial agreement. What complications do you see?

Ann: Boy, that is a loaded one, and there's a lot to dig into there. The first thing I think of is limited liquidity, and I think it's something that oftentimes they don't think about that spot of now here we are at a point where we have to divide something that at least one of them is probably greatly invested in and really loves it and doesn't want to give up half of it. And yet there may not be choices if there's no liquidity.

And what I often find is this idea of ownership versus control. They think about, well, if I own it and you split it, just remember control might get split as well. That might not make you very comfortable as a business owner. So you really want to think about these things in advance.

I often find the idea of voting right concerns, right? So you might be willing to give up half the value, you might not be willing to give up those voting rights if you're the owner and you want to keep running the business.

And then finally, this has an impact on other players. So it definitely has an impact on any investors in the business. They're thinking, gee, now we have this outside shareholder with a large chunk of the stock that doesn't have skin in the game, meaning they're a founder. So there’s a lot of things to unpack there.

I recently ran into a founder that he's built this business and now unexpectedly in a divorce, no prenup. And 42 months in, they are still not at the mediation table and they're not there because they have no liquidity for him to buy her out. She doesn't care if she owns the company, but he doesn't have the money to buy her out either. And so what are they going to do to get there?

Nerre: Right. Control is important. But even trying to buy someone out, a buyback arrangement might be worthwhile, but the value that I give you today may not be the value of my business in the future. What if it goes down in value and you've been made wealthy by it? It's tough. It's very difficult.

We talked about concentrated business wealth creating unique challenges, and business buyback arrangements may be something to add into the solution mix.

Let's go to our third scenario. We've got an entrepreneur, and the wedding is approaching. They've got significant future growth potential. So we talked about our entrepreneurs being very risk-tolerant, very optimistic, but this one really looks like they're going to have a big liquidity event in the near future. But with that wedding approaching, what are some planning considerations they should be thinking about?

Ann: Well, I would tell them to definitely think about a prenup, but I would think about a prenup in terms of your timing. So I have seen the examples where people waited until a week before the marriage and they pulled out the prenup. Don't recommend that.

But a prenup is a great way to kind of set down what you would like to have happen if things go wrong. And it gives room for some discussion, I think, with this future spouse. But if a prenup hasn't been done and now you get to the other side of a marriage, postnups also might work in limited circumstances as I'm sure you would mention, Nerre.

And then the other thing I've definitely seen used, I once had a founder that had built a business, sold it, got divorced, was not happy that he lost half of it in the divorce. And now he was on the cusp of a new marriage, and he also had a new business.

And so I said to him, of course you're going to do a prenup this time, right? And he said, oh no, no, no, I'm not really comfortable with that, but I am going to use separate property trusts. And so that's what he opted for. I still recommended the prenup, but having any of these things set down in writing and separated before the marriage helps.

But it's also really important when you think about titling and such just to remember it matters what state you're in as well when you start thinking about how things are titled and what it would look like in a future marriage.

Nerre: Absolutely. So the separate property trust, I really like that idea. That one is a good alternative if somebody is just completely averse to the prenuptial agreement. Separate property agreements work, which is basically a trust where you put title to all your separate property in the name of that trust.

But the key to making it work is keeping that property separate, and that's hard work. You've got to make sure you don't use those assets for the benefit of the marriage or share it in any way. And in that case, the title can really start to become blurry.

And the other thing I'd like to point out is there are lots of personal planning solutions, but we want to layer on protections. Just like how when you go out in the cold, you're more likely to stay warm if you layer a couple of shirts on rather than wearing one bulky sweater. We do the same with our planning. So if you have that prenuptial agreement, you have that separate property, you have all your beneficiary designations. Make sure your business documents also can support the plan or the goals that you have.

So documents that you put in place for your entity could be articles of incorporation for a corporate business, operating agreements, partnership agreements, membership agreements for an LLC, even additional agreements like bylaws. They frequently contain provisions that prevent somebody from being a partner without consent of the whole organization or a board or give them a lesser status without voting rights, give right of first refusal to other co-partners or members or managing members. There are lots of choices of provisions that can go in place so that you have many layers to your wall of protection—especially if one layer fails.

So those prenuptial agreements, I think we're in favor of them because before you actually get married, you're both coming to a mutual agreement of this is what we want to happen. And I think people think of them as being maybe lopsided or only benefiting one party, when that's not actually the case.

Ann: Yeah, and it seems like that people are hesitant to use these, but what I love about these documents is they can get really detailed, and so they give them a lot of flexibility.

Nerre: Yes, yes. In fact, there's one that really sticks out in my mind. So we had a client one time who married a woman who was particularly wealthy. Her family was very wealthy, and I would say her dad didn't really see him as worthy of his daughter.

So they had a prenuptial agreement, and one of the provisions in the agreement was that the first $40 million that he earned goes straight to her. There was no split. She just got that off the top. And then anything in addition that he was worth after that, they would split 50-50. And I remember looking at this thinking, wow, you're not worth $40 million. Why would you agree to this? This seems sort of harsh.

But it almost acted as incentive and motivation for him to prove himself to both himself and her dad, so that within a few years he sold his business for $60 million and was way clear of that threshold that he needed to meet should they divorce. So in some ways, it can really enhance the marriage. I thought that was really fascinating.

Ann: Yeah, very interesting and kind of unusual, but I do think it's amazing what drives people to perform.

The other thing, I think, timing matters so much. And so the earlier, the better when you start thinking about prenups. We were talking earlier about try to have the conversation before you even get to thinking about marriage, about your philosophical views around prenups. Try to blend that into the conversation so that it just becomes the norm.

Talk about your values, talk about risk, talk about your future and make it a habit to have these conversations regularly so you really begin to understand each other. Because again, like it or not, it's a financial arrangement, whether we like to believe it or not.

And then I can't reiterate too strongly the idea of state law matters. I have plenty of clients in California that have moved to Texas and vice versa. And boy, that can change things if you don't have any documents in place. The way the titling works, the way that this court system will look at ownership matters quite a bit in those situations.

Nerre: So I want to get into our fourth and final scenario, and this is one that I don't think people give enough consideration to. When we talk about value, we're often talking about the founder spouse, the business owner spouse, what they built, what the business is worth. But actually, there's real value in that other spouse. So sometimes that other spouse is working to support the founder while they build a business, or sometimes that spouse is taking time out of their career to do things that require them to stay at home.

All those actions, while they're not paid outright, are of real value. And at times, we've seen people come into a situation with that and then ultimately face a conflict. What would you say is a good planning opportunity to deal with that, Ann, in a situation where the spouse spent years supporting an entrepreneur to build a business?

Ann: Yeah, I think if you're the business owner, I think sometimes you probably underestimate the security that it's given you to have that spouse there doing those things. Whether it is the career or building the family, they oftentimes feel like they built it, and they underestimate how much impact that spouse had in that arrangement and how much it allowed them to grow that business.

And they almost always will think short-term sacrifices today are going to build long-term growth. And so I think they underestimate sometimes the risk factor of taking on debt to grow the business or whatever that is. They tend to be very focused on how much impact in a positive way it's going to have and very little time on the negative impact it will have on their family.

Nerre: That's a really good summary. Just because people have differing priorities doesn't mean it's wrong, but they really need to communicate what their expectations are and then align on their goals.

So marriage and business are probably two of the biggest financial commitments that anyone can get into and make. And when they intersect, the communication, the planning that's needed is really key to making sure they're both successful endeavors.

Ann: Yeah, I think just some takeaways for business owners to be thinking about as they enter into marriage. Number one, and we just can't reiterate this enough, talk early on. Communicate clearly. Reiterate, have the conversations over because as you pointed out, things change. So it has to be a constant process.

Understand the risks and the rewards tied to the business. So often, I think business owners are like, oh yeah, I'm going to make a lot of money. And they don’t always put into its proper place the risk of it and the risks to the family when they do that.

Put together legal and financial plans in place long before they're needed. That makes everything so much easier when you don't have a problem and you have time to really think about it, and it's not this emotional piece that’s involved in it.

And then again, revisit over and over and over. That's how a marriage works, that's how you keep everyone aligned and that's how we move forward.

Nerre: And remember, you can always bring in a bank partner to act as a buffer in those early days so people aren't feeling put on the spot or misinterpreting the intent.

Thank you for listening and joining us for this episode of Building More Than Business. Be sure to check the show notes. We've included a prenuptial checklist and some other information for you if this topic is timely for you. And if you enjoyed today's discussion, please share it with a friend. You can find us on Apple Podcasts, Spotify or YouTube Music, and we'll look for you next episode. Thank you for joining us.

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