Divorce for Tech Founders: What Happens to Your Shares and Stock Options?
As a founder, your shares and options are often your most valuable asset, and a divorce settlement can feel like losing control of your life’s work. This article will cover how your equity may be valued on divorce; whether or not it is “matrimonial”, i.e. to be included in the marital pot for potential division on divorce; some options to protect your stake; and other considerations such as tax.
1. Why founder equity is different
Equity in a company is treated differently, as it should be, in Family Law to both salary and other investments such as shares in publicly listed companies, bonds or investment funds. If you are not employed by the company and all your shares in the company are vested, then the shares’ treatment can be quite simple, though of course valuation issues may still arise. However what if your stock is not yet vested and is reliant on continued work? What if you separate before it is fully vested? What if you leave the company before it all vests? What if you set up the company and/or were awarded some of the stock before you got married, but have received more shares during your marriage? Is unofficial (verbal agreement) or official (contractual) “sweat equity” taken into consideration?
From your point of view, your equity represents your creation of an asset with its own life-form and financial obligations. It is not necessarily about its face-value, which itself is probably hard to determine and nascent. If some of the shares were transferred into your spouse’s name on divorce, what implications would that have for the company? What tax would arise on such a transfer? Any prospective sale may be years away so what role would your spouse play as a shareholder in the meanwhile?
Founder equity and its treatment on divorce clearly carries some complexities that other sources of income and other capital investments do not.
2. Matrimonial or non-matrimonial?
Simply put, the starting point on divorce is a 50/50 division of matrimonial assets, unless one party’s financial needs require that they take a larger than 50% share. Needs is an elastic term but will essentially be their ability to meet their own housing needs and their day-to-day living costs, taking into account their income, mortgage capacity, and any other financial resources available to them such as savings and investments. It is a reasonable assumption at least as a starting point, however, that if an asset is matrimonial it will be treated as an asset to be shared equally with your spouse. So what makes your equity matrimonial or not in the eyes of family law?
A matrimonial asset is one that is the product of a party’s endeavours during the marriage, or the parties’ joint endeavours. “Endeavours” differentiates these assets from non-matrimonial assets such as gifts or inheritances, which are not seen to be the “fruits of the marriage”. Equally, any asset that is pre-owned and brought to the marriage by either party (“pre-marital”) is not matrimonial. Divorcing spouses should note that a “marriage” is deemed to start when a couple start cohabiting, provided that cohabitation period moved seamlessly into marriage. Therefore the years you lived together before your wedding count towards your years married.
English family law sees no difference between a founder’s endeavours in building up a business and their spouse’s endeavours in supporting that work, regardless of whether or not the spouse was working, particularly if they have raised the parties’ children or if it has been a long marriage.
This means that if you have founded a business during your marriage, and you have been married a long time (say, more than 10 years), in theory your spouse could be entitled to half of your business. If you co-own the business with fellow shareholders, then your spouse could be entitled to half of your share in the business.
What is relevant is the proportion of the business that you own at the time of separation – though a recent divestment of stock prior to separation can be reversed in certain circumstances (see further below).
If you set up the company prior to marriage (including pre-martial cohabitation) so owned the business then, but it was in its early stages and its value was highly speculative at that time – or it had a low valuation then that has since increased – then the growth in the value of the company is treated as matrimonial. I.e. the difference between the value of the company at the time of marriage vs. the value at the time of separation is matrimonial.
This is obviously a daunting thought for founders who have built up a profitable and valuable business while they have been married. We consider in this article how you can protect yourself prior to any potential future divorce.
3. Restricted stock and share options: Matrimonial or non-matrimonial?
Fully vested stock that you earned/ were awarded to you during the marriage will be valued as at the date of your separation. As above, if yours is a long marriage (10+ years), in theory the full value of those shares could be treated as matrimonial, since their full value was acquired during the marriage. Remember that “marriage” includes any prior period of cohabitation that seamlessly progressed into marriage.
Stock that is fully vested as at the date of separation, but which was awarded prior to your marriage (see note above re: cohabitation) is treated differently. Only any increase in the value of those shares since the marriage is matrimonial.
If you have a long separation before you divorce and resolve the finances associated with your divorce, shares that are awarded to you post-separation could be deemed to be non-matrimonial and will be excluded from the marital pot for sharing purposes on divorce (although this will depend on the circumstances of the award).
Stock that vests post-separation but prior to resolving the finances and that was awarded to you during the marriage is matrimonial. Their value as at their vesting date is their matrimonial value. This is because they relate to the period of shared marital “endeavours”.
Unvested stock and share options are the trickiest area, since often their vesting is reliant on your continued work in the company as at the vesting date. Unvested stock and share options that are granted to you during the marriage are potentially matrimonial, even if you separate during the vesting period. If you separate part-way through the vesting period, a time-based apportionment may be applied so that only a percentage of the shares are treated as matrimonial (since some of the share value will relate to the post-separation period).
Attributing a value to a share option today is nearly impossible because all the following factors must be considered:
- the terms and conditions associated with the award;
- the likelihood of the shares vesting;
- their likely value on vesting;
- whether it is appropriate to apply a percentage discount to the value of the options to reflect the risk of forfeiture on leaving the company, or the risk of the company depreciating in value; and
- any tax considerations, as only the net value of the shares are matrimonial.
This means that in nearly all cases, if a spouse holds share options, their financial order will state that the shares (or the cash value received for the shares) will only be divided between the parties when the option-holder actually receives the shares. That way both parties share in the risks outlined above.
4. Valuation issues
Valuing a business as at a specific date is difficult where the company is private or unlisted, as the majority of tech companies are. Valuation might rely on recent funding rounds, profit forecasts, or other internal data.
A valuation expert can be jointly instructed by the divorcing parties to advise them on the likely value of the company today and at a specific date in the past (for example, marriage or separation). Experts can be instructed to reach an earnings-based valuation (an EBITDA multiple); an asset-based valuation (net balance sheet value); or a discounted cashflow valuation – or indeed all three.
5. If matters go to court
Your greatest concern may be a forced sale of shares in the business or, if there is no market for sale of the shares, transfer of those shares to your spouse on divorce. In reality, both of these outcomes for a private business with few shareholders are unlikely and the court will seek to avoid them.
The most common approach taken by the court is ‘off-setting’, whereby the non-shareholding spouse receives a greater share of the remainder of the matrimonial assets in lieu of the shares. Cash, other investments, the equity in the family home and pensions can all be applied for this purpose and you may be prepared to sacrifice your equitable share in any or all of these in order to retain your business interest.
The challenge, of course, in off-setting is valuing your business interest at the time of divorce in order to calculate the degree of off-setting that needs to be undertaken elsewhere. The valuation of your business as at the relevant dates will likely be a critical matter for dispute. The court can direct that a jointly instructed single joint expert is appointed: this person is typically chosen by one party putting forward three potential experts (with evidence of their expertise) and the other party choosing one from that shortlist. That expert owes their obligation to report to the court rather than to the parties, and all correspondence with that expert must be copied to all parties. They will produce a report and, if necessary, can appear as an expert in court and be cross-examined on their report in a final hearing.
The second most common approach taken by the court – and this may be the only option available if there are insufficient other marital assets around in order to off-set your business interest – is deferred sharing of your business interest. Your spouse retains a beneficial share in your shares and, on the ultimate sale of those shares, they receive a percentage of the proceeds.
Off-setting can be used in conjunction with deferred sharing such that your spouse’s beneficial interest in the shares is reduced.
The downside of deferred sharing is a lack of certainty for the non-shareholding spouse, and a lack of a capital clean break between you. A financial tie between you remains unresolved unless and until the shares are realised.
Specialist tax advice should be taken on the implications of the above options. A tax expert would be jointly instructed to provide a report and, if necessary, be available for cross-examination of their evidence at any final hearing.
6. How to solve matters via reaching a settlement
Much like with the court route as set out at (5) above, settlement agreements will typically seek to either off-set your business interest in the overall asset division, or allow for your spouse to receive a proportion of the proceeds of your business interest once sold in the future.
If seeking to off-set, you may consider hiring a valuation expert to assist you in valuing your business interest. Specialist tax advice should also be sought as above.
Please note if you reach an out-of-court financial settlement with your spouse it is essential that you instruct solicitors to write that agreement up into a court order by consent, and apply for its approval by the court. This is because if you do not have a final order sealed by the court stating that its terms are in full and final settlement of all financial claims associated with your divorce, your spouse could return to court at any time in the future seeking financial relief from you. Their claims would then be determined at their time of application, by which time your business may have trebled in value.
7. How to protect yourself in a marriage, prior to any separation
A nuptial agreement is the best possible way to protect yourself from claims against your business assets in any future divorce.
If you are not yet married, you must enter into a pre-nuptial agreement prior to any marriage. This would state that your future spouse will not acquire any legal or beneficial interest in the business whatsoever by virtue of your marriage. Please refer to our specific articles on pre-nuptial agreements here:
The Complete Guide to Pre-nuptial Agreements in England and Wales
Pre-nuptial Agreements: are they binding, and are they worth it?
Are pre-nuptial agreements legally binding in the UK?
Are Pre-Nuptial and Post-Nuptial Agreements Legally Enforceable?
Presuming you are already happily married, you should consider entering into a formal written agreement now with your spouse as to how your business would be treated on any future divorce between you. Ideally, you would seek to agree that the business can be entirely ring-fenced from any financial settlement on divorce. This would strictly speaking be a “post-nuptial agreement”, but it need not consider all of the financial terms that would apply to your divorce – it could deal exclusively with the business. Whether or not a total ringfencing is appropriate or possible will depend on the wider financial circumstances of your marriage. If your business is your sole marital asset, or considerably the most valuable marital asset (for example, you have committed your life savings to it and your family home is heavily mortgaged/ you live in rented accommodation), then total ringfencing may not be possible. This is because after any ringfencing your spouse’s housing needs and income needs must still be met. If there are not sufficient other assets or income to meet those needs excluding the business, then a post-nuptial agreement that seeks to ringfence the business in its entirety from consideration on divorce will not be considered fair and is unlikely to be upheld on divorce.
If, however, you and your spouse own other valuable assets or have other financial resources – for example, your spouse is a high earner/ there are cash and investments and your family home is of sufficient value that you could both re-house with 50% of its net sale proceeds – then a post-nuptial agreement stating that your spouse will not be entitled to any share in the business on divorce may be upheld.
There may of course be some difficulty in agreeing a post-nuptial agreement with your spouse during the marriage; it will precipitate some difficult conversations and you will both need to instruct family law solicitors to independently advise you on the terms of the agreement. You will also need to exchange disclosure at that time as to your financial situation, including an estimated value of the business. This is because in order for the post-nuptial agreement to be upheld, your spouse must know the value of the asset to which they are “signing away their rights”.
There is a far higher chance that you will be able to agree to a post-nuptial agreement while you are happily married than if separation is on the horizon, as clearly at that stage your spouse will be very cautious not to prejudice any potential financial settlement on divorce. The sooner following a business’ inception that you can act to ringfence it in a nuptial agreement, the better.
8. FAQs (Frequently Asked Questions)
In short, yes, if you established the business during the marriage or it was valueless before the marriage. This does not mean that half of the shares must be transferred to them on divorce, but it does mean that the value of those shares may need to be paid to your spouse on divorce or that they will receive a greater share in (or all of) the remainder of the marital assets.
Typically your spouse will acquire their half-share in your options on their vesting date. Otherwise you may need to off-set that value in any financial settlement reached at the time of divorce, but valuing those options is very difficult.
Valuation might rely on recent funding rounds, profit forecasts, or other internal data. If valuation is a particular issue in dispute a business valuation expert would be instructed (either by agreement between you, or by the court) to provide a valuation report.
Yes absolutely, and this is the most common approach taken by the court in dealing with these matters provided there are sufficient other assets to be transferred to your spouse in order to meet either their “sharing” claim or their “needs” claim.
Transfers of assets to an ex-spouse pursuant to a financial order associated with a divorce are generally exempt from capital gains tax. If, however, you have to dispose of shares or business assets in order to raise cash to meet a financial settlement, this may give rise to capital gains tax so specialist tax advice should always be sought prior to any final settlement or final hearing.
If you are not yet married, then yes, definitely! If you are already married, you should consider proposing a post-nuptial agreement.
9. My experience
My name is Kate Pooler and I am an Associate at Edwards Family Law. I have six years of experience working in Family law and I have helped numerous business-leaders, primary shareholders, stock option-holders and founders navigate both nuptial agreements and divorce. Please do not hesitate to get in touch should you have any questions arising from this article.