Startups in the Whirlpool of Divorce

Startups use stock options to compensate their employees. An employee’s divorce could result in a change in the formal ownership of the startup securities. However, the startup, the employee, and the former spouse of the employee all have considerable and conflicting interests in the outcome of the allocation of the employee’s securities as part of a divorce settlement. I argue that the startup, along with the relevant tax rules, imposes obstacles on the transferability of the securities to the employee’s former spouse that are likely to distort the settlement outcome.

An inefficient outcome is likely because the person who may assign a higher value to owning the securities is both barred from owning them and prevented from receiving equivalent value in exchange. While amending the IRC would allow for more outcomes and could enable the parties to reach a more efficient result, corporate law’s attempt to protect the shareholders’ rights and scrutinize contractual arrangements such as voting agreements and appraisal waivers could have an ex-ante unintended consequence. Specifically, since the startup is likely to continue, it may deprive the former spouse of any equity rights following the divorce and attempt to prevent possible complications to future corporate transactions once the tax pretext is lifted.