The Impact of Inflation on the Division of Assets for Small Business Owners

The Impact of Inflation on the Division of Assets for Small Business Owners

Jennifer Fletchall
Illinois Fellow
American Academy of Matrimonial Lawyers
April 2022
Division of Assets in a small business

The United States has hit the heights. That's not a good thing.

In 2022, the annual inflation rate in the U.S. accelerated to 7.9%— the highest since February of 1982. (Keep in mind that in developed countries, including the U.S., anything above 4% is considered "high.") And inflation is predicted to increase in coming months as we start to feel the impact of the war in Ukraine and the world's sanctions against Russia.

Inflation is the rate at which the value of the dollar falls at the same time that the price of goods and services is rising. This reduces purchasing power. The math is pretty straightforward. Higher costs for businesses lead to increased prices, which raise the cost of living. This in turn may lead to demand for higher wages, which results in worker shortages if employees leave for better pay from a competitor. These shortages can force businesses to offer higher wages to entice workers to return—which means higher costs. And the cycle begins again.

From a macro-economic standpoint, as prices rise, the value of a country's currency begins to decrease. But inflation also can quickly filter down to individual households, where the largest assets are the marital residence, retirement accounts and businesses—all of which must be properly valuated during a divorce settlement.

To gauge the impact of inflation on a personal level, just check your retirement account balance; if it's lower than it was three months ago, inflation is most likely the cause. Inflation also can reduce the value of the marital estate; the future cost of consumer spending; the value of spousal maintenance; and especially the value of the small business that has supported the home and purchases over the years. (All of these factor into the division of assets.)

For a small business, inflation's effects may not immediately be obvious.

  • Inventory Costs. Inflation causes businesses to pay more for inventory as well as materials. If these costs cannot be met, it can lead to an inventory shortage.
  • Employee Wages. When the price of goods increase, employees will want a higher wage. If a company is unwilling or unable to increase wages, talented employees may leave.
  • Consumer Purchasing. Another consequence of rising prices: the number of consumers buying those goods decrease.
  • Investment. To correct inflation, the Federal Reserve hiked interest rates in mid-March, for the first time in three years. Higher interest rates often deter business owners from borrowing money for investments in equipment and facilities.

To achieve an equitable appraisal, business owners should strongly consider employing a business valuation expert, who will typically choose one of three methods: the Asset Approach, the Market Approach or the Income Approach. Most of these experts, when valuating a small business for a divorce settlement, will choose the Income Approach. It includes an analysis of the business’s cash flow over the last five years, as well as projections of future cash flow. Notably, the business valuation expert also will determine the impact of inflation, along with other factors, on that cash flow.

Inflation impacts the value of a business primarily in three areas.

  1. It can alter the risk-free rate, which is used in calculating the cost of equity. As the name suggests, the risk-free rate is the rate of return an investor would expect on an investment that has no risk. It is determined by using the interest rate on a Treasury Bill, a very safe investment since these are backed by the government. As interest rates rise, the risk-free rate will also rise—which, all other things being equal, would decrease the value of the business.
  2. Inflation may also affect the after-tax cash flow of a business. If a business incurs additional costs due to inflation—and if revenue does not rise accordingly—a business’s after-tax cash flow will decrease. Again, all other things being equal, this can decrease the value of the business.
  3. Finally, inflation can change the effective tax rate paid by a company. Take the example of a company that deducts depreciation expenses related to newly purchased equipment. If decreased cash flow (or lack of funds) prevents the business from making such purchases, it will have no new assets to depreciate; the company then loses the opportunity for pre-tax depreciation. Inflation is the root cause, and this too will reduce the business’s value.

Inflation not only afflicts individual consumers faced with higher prices at the grocery store, the gas pump and the mall. It also affects small businesses that already are walking the tightrope between increased costs and maintaining profitability. If the business owner is in the process of obtaining a divorce, inflation must be considered in calculating the value of the business—and, correspondingly, the value of the marital estate—to arrive at a fair and equitable conclusion.

Jennifer Fletchall

Co-Parenting in the age of COVID-19

Co-Parenting in the age of COVID-19

Tiffany Alexander
Illinois Fellow
American Academy of Matrimonial Lawyers
March 2022
COVID Divorce

Judging from tabloid television and social-media memes, the subject of divorce holds the same fascination as a highway accident: many people know it’s bad but can’t look away. And in the last two years, that gapers’ block has turned into a 24-mile traffic jam.

During lockdowns, many couples quickly realized they didn’t want to spend that much time together. The worldwide disruptions caused by COVID-19 have only amplified the usual reasons to initiate a divorce. But a substantial portion of legal disputes arose from unexpected changes in the family dynamic due to the global pandemic.

During the last two years, we have seen a flood of new issues involving alimony and modifications of child support; relocation of children; changes in parenting time to accommodate high-risk family members and essential workers; and enrollment of children in remote-learning versus in-person classes.

The level of conflict has escalated since 2020, with even more issues stemming from our “new normal.” This altered landscape also has intensified the role of divorce attorneys, who often find themselves acting as mediators and parenting coordinators for families unable to move forward after so many months in gridlock.

In so many situations, people’s respect for the opinions of others has greatly diminished, as you can see by spending five minutes on social media. The list of taboo subjects now includes masks and vaccines for children. Sadly, in the absence of parental cooperation, the legal system is forced to render decisions on these divisive issues, which almost always results in further conflict.

Here are several cases to illustrate particular problems that have arisen during the pandemic and continue to affect separated families. While hypothetical, they all are drawn from my own experience with couples who had entered into joint parenting agreements before the pandemic. These families had spent years working through their differences and effectively co-parenting, even after they had remarried and established new households in suburban Chicago.

  • In July 2020, Susan and David disagreed on schooling. Susan, a teacher, adamantly supported their children’s return to classroom learning, in line with her own decision to teach in person. David, whose employment allowed him to work at home, remained concerned about infection in a school setting. He filed a motion to prevent his children from attending classes in person.

    A guardian ad litem (GAL) was asked to make a recommendation, which the judge used in ordering a program of hybrid learning where the children spent the remote portion of their school day at their father’s house. This solution mitigated but failed to alleviate David’s concern. By leaving it up to the court, he essentially conceded his responsibility to jointly decide the best course of action for their children.

  • Pre-pandemic, George’s work schedule required his former wife Betty to act as their children’s primary care provider. When George began working from home in 2020, he was able to take a larger role. So, in April 2021, and with his second wife also home full-time, George petitioned the Court to evenly split their parenting time. George argued that the children were thriving thanks to his increased attention.

    After a GAL was appointed to investigate, George filed an emergency motion to restrict Betty’s parenting time, on grounds that Betty and her new spouse were not vaccinated, and that they traveled to Wisconsin with no concern about exposing the children to COVID-19. George grew concerned that their carelessness might result in the children spreading the virus to his newly pregnant wife. Refusing to acknowledge and negotiate changes in their home lives, the couple essentially asked the court to validate one parent’s life choices over the other, using the children as a wedge. The emergency motion languished, but the filing spurred more animosity in subsequent motions over co-parenting.

  • Last June, Sean wanted his teenaged son to get vaccinated. Sean’s ex Liz objected, claiming that because the boy had already contracted the virus he was likely immune. The son told both parents that he wanted the vaccine in order to hang out, unmasked, with his friends. Noting the son’s preference, the GAL recommended vaccination, to Liz’s chagrin. When vaccine eligibility was extended to younger children, Sean—wishing to avoid another Court dispute—scheduled their 8-year-old daughter for the shot without seeking Liz’s approval. He then asked the child to keep her vaccination status secret, dragging her into their fight and jeopardizing her trust in both parents.

In each of these cases, the ability of parents to cooperate eroded under the weight of the pandemic, leading them to cede important family decisions to a guardian ad litem and an unfamiliar judge. Ongoing litigation feeds further animosity; parents channel unprecedented stresses into mutual distrust. They fail to hear their children’s voices. And the kids are not all right. They have been left to advocate for themselves, through a GAL, when what they need is support and assurance from both parents.

In the same way that a series of adrenaline rushes can physically fatigue the body, the steady drumbeat of virus-created stressors has fatigued the spirit, crippling these parents’ capacity for compassion and cooperation in addressing solvable issues.

Similarly, the onslaught of novel crises during the pandemic—with no valleys of calm in between—has deepened the cracks in the family legal system. COVID-19-fueled disputes have added to the caseload: one dispute after another, fewer periods of reflection, more fighting, more GAL appointments. As a result, co-parenting arrangements now must include new discussion of remote learning, masks, travel, vaccines and more. This global pandemic has irrevocably changed family court proceedings, as the court faces an increase in the newly contentious issues that have been added to its docket since 2020.

Tiffany Alexander

The Modern Prenup

The Modern Prenup

Shana L. Vitek
Illinois Fellow
American Academy of Matrimonial Lawyers
February 2022
Prenup cartoon

On a recent episode of “Shark Tank,” two entrepreneurs pitched an investment in their online business called “HelloPrenup.” Engaged couples can create their own agreement “together” on this cheerfully designed website. They complete a questionnaire; pay about $600 to obtain the completed contract; and can then make their agreement official by signing it without consulting an attorney.

My anxiety escalated just at the thought of couples who rely on preprogrammed questions—without legal advice—to create legally binding prenups. I waited for the Sharks to start pointing out all the problems I saw with this process. To my surprise, not one but two Sharks ultimately invested in the business.

Approximately 2.7 million marriages will take place in the United States in 2022. Of those, an estimated 5% of couples will have executed a premarital agreement before walking down the aisle—a surprisingly low percentage considering the U.S. divorce rate consistently drifts between 40% and 50%. Many lawyers see a specific uptick in the number of millennial couples requesting a prenuptial agreement. One factor is that the average age of those in first marriages has risen, which means that each spouse has had more years to work and build wealth they wish to protect.

The website “HelloPrenup” promises a “frictionless prenup for modern couples.” But who are these “modern couples?” If they are two healthy individuals with similar incomes, who do not plan to have kids, I could envision this “frictionless” prenup working. But this is not the typical prenup client. More commonly, one spouse has (or expects to have) substantially more wealth than the other. And the other spouse signs the agreement — without due diligence or understanding what is being surrendered—to prove it’s not about the money.

Consider the following scenario: Jack and Jill plan to get married. In their early 30s, both have good jobs and retirement accounts with similar balances. As a “modern couple,” they decide to create an online prenup. Because they earn similar incomes, each agrees to waive maintenance. They agree to keep their own retirement accounts and any other accounts in their sole names. They agree that any joint assets should be split 50/50. Easy, right?

Now jump ahead 13 years or so. Jill stopped making retirement account contributions since quitting her job four years into the marriage to care for their three children— one with special needs. Conversely, Jack now earns five times more than when they married; has received a large inheritance; and has a million-dollar retirement account.

Many would say that due to these changed circumstances, enforcing the terms of this prenup would be unfair: a court would never uphold that prenup. They would be wrong. In fact, the court will most likely find the agreement fully enforceable.

Premarital agreements should not be taken lightly. They are powerful contracts that can effectively and efficiently protect both spouses in the event of divorce. That’s why both parties need their own attorney to review the agreement prior to signing it. Just as no two divorces are exactly the same, no two marriages are exactly the same—and no two prenups should be the same.

Lawyers can ensure the terms are legally fair for both spouses. And keep in mind that as circumstances change, your prenup can be supplemented, modified or voided by agreement during the marriage. Knowledge is power.

There are several reasons for each party to hire an attorney to review and advise you about a prenup:

  1. Divorce laws vary from state to state. If you don’t know what the law entitles you to have, you won’t know what you are giving up.
  2. Devastating outcomes can result from poorly drafted prenups, and not just for the spouse with less money. A spouse who is wealthy on wedding day may have agreed to pay a lump sum to the other in the event of divorce, but later experiences a financial catastrophe. That spouse may still be required to pay that substantial lump sum.
  3. A prenup is nearly impossible to invalidate, and many include clauses that penalize a spouse for challenging the validity of the prenup. For example, if someone challenges the prenup and loses, they could be ordered to pay the other’s attorney fees in addition to their own.
  4. Plans change. Couples who don’t plan to have kids change their minds. People change careers. What might have seemed fair at the time of the marriage may be completely inequitable 10 years later.
  5. Having lawyers review a prenup provides an added layer of validity. The presence of attorneys makes it much harder for someone to claim they didn’t know what they were signing.

Over the years, many divorce clients have told me they wish they had entered into a premarital agreement before tying the knot. But that desire was ultimately outweighed by the fear of offending their partner or creating conflict during this joyous time in their lives. So, what is the best way to broach the topic with your future spouse without derailing the entire engagement?

Negotiating a prenup is not something you should do the week before the wedding. Raise the idea of a prenup as soon as possible, even though you may be uncomfortable doing so. If diving right into the topic is intimidating, start a conversation about how you would like to handle finances during your marriage. Do you know what assets and debts your spouse has? Will either’s home become the marital residence, and if so, how will the expenses be paid? Will bank accounts be kept separate?

As these conversations unfold, you can easily pivot toward the possibility of a prenup. And if you agree to create one, schedule a time to consult with attorneys to understand the process.

People don’t get divorced without an attorney, so why would they create a prenup—which will dictate what happens in a divorce—without an attorney? The divorce rate approaches 50%. If you booked a vacation and knew there was a 50% chance you would have to cancel, wouldn’t you pay for travel insurance? You can apply the same risk management principle here.

Shana Vitek

©2022 Illinois Chapter of the American Academy of Matrimonial Lawyers