Divorce becomes significantly more complex when it involves equity compensation, such as stock options, restricted stock units (RSUs), and company shares acquired via these and other types of equity awards. As with other valuable assets, a prenuptial agreement is one way an engaged couple can, prior to their marriage, address any potential divorce and protect equity comp earned before, during, and after marriage.
A prenup allows a couple to set their own rules for any future divorce-related asset division—and to do so at a time when their relationship is loving and conflict-free. Without a prenup contract, if the pair later decides to split, a divorce court in their state will instead divide the couple’s assets according to state law. This could result in a costly loss of control over earned wealth, such as stock compensation.
While it’s not the most romantic activity, drafting a prenup (more formally termed a premarital agreement) is a smart idea for many reasons. The Institute for Family Studies estimates that, while divorce rates in the United States have declined over recent decades, roughly 40% of today’s first marriages will end in divorce.
In a recent webinar that I moderated, two experts in the legal, tax, and financial-planning aspects of divorce spoke about prenup provisions on equity compensation. This is a topic that, in my long experience as the editor-in-chief of myStockOptions.com, is seldom (if ever) covered by resources on financial planning for stock options, RSUs, and company shares. In the article below, I share some of their insights.
Importance Of A Legal Agreement Before Marriage
“The general idea with premarital agreements is that parties define the rules that they want up front,” said webinar panelist Michèle Bissada, a divorce attorney now in practice as a mediator, Private Judge (JPT/PCTJ), arbitrator, and parent coordinator with Signature Resolution Group in California. “Otherwise, the state in which they live or where they divorce will define the rules for them. And those rules will be the default laws in that state.”
While a contract of this sort can be made after marriage (a postnuptial or postmarital agreement), it is usually better to finalize this type of arrangement before marriage, she added. “A premarital agreement is an arm’s-length contract between parties that are not married. Once they get married, they are not arm’s-length anymore. Marital parties have fiduciary duties to each other.” For this reason, she observed, postmarital agreements are much more complicated to create, as they carry a far higher burden with stricter requirements to ensure that they are legally valid.
Equity Compensation In The Prenup
“For equity compensation, you want to preserve what will remain separate and what will not remain separate,” Bissada explained. For example: Will marital property to be considered for division in a divorce include all equity awards? Will it exclude equity awards that vested before the date of marriage and include only awards that vested during the marriage? “All of these things have to be very well detailed in the premarital agreement.”
Any asset whose rules are left legally vague could later be divided by a court according to the laws of the state. In California, a community property state, that typically means a 50-50 split no matter what, warned Bissada.
Prenup Roles For Both Attorney And Financial Advisor
For equity awards, a couple will ideally include a financial advisor alongside an attorney on the team drafting the prenup. As those of us who work in the stock compensation area know all too well, “employees often do not understand all of the nuances of their equity awards and the assets that flow from them,” Bissada observed.
A financial advisor who is familiar with the stock plan documents and grant agreements of the couple can help the parties and their attorney understand these nuances: for example, the exact types of equity awards and the tax treatment of them; the vesting periods; any performance conditions attached to the vesting; or any feature that defers income recognition for a number of years.
Moreover, Bissada continued, one spouse’s equity awards could be illiquid in a private company while the other has RSUs in a public company that vest monthly, providing regular frequent liquidity. “That will affect how much cash flow is coming for each party.”
Details of the financial advisor’s role in the prenup drafting were explained by webinar panelist Jon Ekoniak, a senior wealth advisor in Menlo Park, California, who works for the national firm Focus Partners Wealth. He recommended identifying not just the types of equity awards but also their dollar values. “That means not only their gross value but their post-tax value,” he added.
Ekoniak further advised the use of “principles-based language rather than fixed outcomes” for mitigating the uncertainty of the future. “One party has only stock options. His company is not issuing restricted stock units now—but what if it does?” It is thus wise to have the prenup refer to all equity compensation rather than just the stock options that he has now.
“Stress‑test assumptions about growth, liquidity, and taxes,” Ekoniak concluded. “Try to break the spirit of the agreement. What can we do, what can go wrong, that will make this complicated? Try to identify those so you can smooth them out before they happen. For a lot of us who have years of experience in seeing these things, we’re going to know many of those situations that could potentially come into play and can work those into the prenuptial agreement from the outset.”
Prenup Checklist For Equity Comp
Specifically, stated Bissada, the couple’s prenup must address each of the following categories of equity compensation and the impact of related events:
- Premarital grants of equity comp and stock holdings
- Exercises of premarital equity compensation during and after marriage
- Grants of equity received during marriage
- Vesting of equity awards, including vesting that occurs after the marriage ends
- Future equity compensation from new ventures during marriage
- Future grants of equity compensation from a current employer
- Equity compensation grants from future employment
- Replacement shares in the event of changes in employment after separation
- Repurchase or forfeiture provisions
Identifying and defining these specifically in the prenup are vital steps for keeping the spouses’ separate equity compensation and stock assets truly separate, she emphasized.
Prenup Rules Must Be Followed During Marriage
Bissada continued with an important warning that may not be obvious once a prenup is drafted and signed: It is not only what you write into the prenup but also what you do during the marriage that keeps the prenup contract legally enforceable. “When parties don’t follow the premarital agreement specifically, they could end up co-mingling assets. As family-law lawyers know, at least in California, things must be fully traced to retain their separate-property nature.”
This is why, she stated, it is crucial not only to establish these rules in the prenup but also to observe the rules in subsequent financial planning and actions during the marriage. Even if the prenup legally states that your equity award shares are yours only, not marital property, you still have to keep them separate during the marriage.
For example, Bissada explained, shares received from equity awards will be deposited into one spouse’s brokerage account. If that spouse transfers the shares to another investment account containing shares jointly owned with the other spouse, they’ve just co-mingled their equity award shares with general community property shares. “Fast forward ten years from now, after shares were sold and proceeds were reinvested and capital gains have come and gone. It’s going to be very difficult to trace through those thousands of transactions.”
Co-mingled complexity of this sort that cannot be untangled may result in the inability of a court to keep the assets separate to one party, meaning they become marital property subject to divorce division as state law sees fit, Bissada pointed out. “How could they be considered separate property if they have been co-mingled?”
For this reason, she cautioned that a prenup should be as simple as possible rather than filled with complexity that works in theory but is hard to manage in practice. “Don’t make it so complicated that they can’t follow it throughout their marriage,” she advised. An excessively complex prenup could, she noted, make it virtually impossible to not breach the contract through co-mingling of assets later on.
Ongoing Role Of A Financial Advisor
Ekoniak observed that this is an area where a financial advisor can, in a long-term way, greatly help to protect the legal integrity of a prenup. In addition to assisting with the prenup itself, an advisor has an important ongoing role to play with the couple to help them follow the rules established in the prenup, he said.
“The advisor can help keep that separate property separate by setting up individual accounts for each of the parties and helping to keep the parties from co-mingling individual accounts with joint accounts.”
Further Resources
The webinar in which these experts spoke, a 100-minute event on divorce involving stock compensation, is available to stream on demand at the myStockOptions Webinar Channel. Other resources on all aspects of equity comp in divorce, including taxes, are available in the section Life Events: Divorce at the website myStockOptions.com.
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