Alternative Investments and Your Orange County Divorce

Divorce can be one of the most challenging stages in anyone’s life. Having the right family law attorney is not just an advantage – it’s an absolute necessity. At Minyard Morris, we understand the details of family law. Selecting a Minyard Morris family law attorney can make a critical difference in achieving the best outcome possible.

With over 600 family law attorneys who practice family law in Orange County, what are the odds that you will find the best one for you and your case?

Minyard Morris has been serving the residents of Orange County since it was formed over 47 years ago. Our family law attorneys limit their practice to Orange County family law matters and have a combined nearly 300 years of experience. If you want a firm that is large enough to address any crisis you may have during your case, retain Minyard Morris.

In 2024, Best Lawyers in America® listed 19 of 20 Minyard Morris family law attorneys, a recognition that is unparalleled for a family law firm.

What Alternative Investments Should I Consider In My Divorce?

A divorce is a division of a partnership where the community assets must be divided equally between the parties. In fact, Family Code section 721 incorporates parts of the California Corporation Code in recognition of the fact that a marriage is a partnership. The Corporation Code refers to a partnership, but that word has the meaning of a marriage in context. When dividing a partnership, parties and lawyers need to understand the nuances and nature of the assets owned by the parties. How can the assets be analyzed, equally divided and distributed unless the nuances, risks, related liabilities, and values are understood. Lawyers have an ethical duty to understand the issues in a case or decline representation. When interviewing lawyers, an individual considering filing for divorce should inquire as to the lawyer’s knowledge and experience relative to the issues and assets involved in the case.

Hedge Funds, Private Equity Funds, Venture Funds and Individual Investments in private companies fall into an asset class known as Alternative Investments, known as “Alts” in the investment industry. Alternatives include a very wide variety of investments that generally are not publicly traded. However, there are exceptions like: Blackstone (BX), Blackrock (BLK), KKR (KKR) and the Carlyle Group (CG) which are publicly traded. Alts are becoming more and more popular in the investment world because of their potential higher yields and the fact that they are less correlated to the public markets, meaning that they do not increase and decrease in value in lockstep with the public securities. They are also being more widely purchased by investors because the us security and exchange commission has relaxed the qualifications necessary to qualify to invest in Alts. Of course, there are negatives related to investing in Alts.

Generally, an investor is locking up the invested capital for two to 12 years when acquiring one of these investments. In theory, an investor is paid a higher rate of return in part because of the lock up and lack of liquidity of the investment. The fees charged by the fund are significantly higher than investing in the public markets and range from 1.5% to 2.5% of either committed capital or invested capital, which means that the actual fees as a percentage can be significantly higher than those percentages especially when the fund’s “carry” is considered.

Calling something a private equity fund does not disclose a lot about the fund other than it invests in private companies or private debt. private equity funds invest in many areas including, but not limited to, the following investments:

Private Credit and Debt: These investments include private placement debt, distressed credit, asset-based loans, mezzanine financing, etc.
Infrastructure: Infrastructure investments are made in pipelines, bridges, data centers, toll roads, etc.
Sports Teams: This is a newer concept that has gained significant popularity. investments are being made in soccer, baseball, hockey, and basketball.
Real Estate: Investments are made in all types of real estate including storage facilities, multi family, commercial, industrial, farmland, etc.
Commodities: This investment includes the purchase of oil and gas, wheat, gold, etc.
Roll Ups: This is the process of purchasing multiple small companies in the same market and merge them together.
Leverage Buy Outs (LBO): This is a transaction where a company is purchased using a large amount of borrowed money.
Niche Industries: These investments are made in specific areas like the purchase of defense contractors, enterprise software, fitness, etc.
GP Stakes: A GP stake is a minority interest in the management company and general partnership of private market sponsors (private equity firms, venture capital firms, wealth management firms).
Secondaries: These investments are the purchase of an asset or a portfolio company, at a deep discount, by one private equity fund from another. Often it is the purchase of one of the last remaining assets in an older fund who seeks to wrap up the fund.
Hedge Funds: This is the investment of private money in publicly traded securities using sophisticated trading techniques like short selling, derivatives and leverage to increase performance.
Venture Funds: These funds invest in companies in their infancy that are often focused in emerging technology.
Fund of Funds: This is an investment in a portfolio of different private equity funds.

Terms

General Partners form the fund, raise the money, and run the management company

Management Companies manage the day-to-day operations and fund the operational expenses

Limited Partners are the investors in the fund not in the firm.

Investors are endowments, pension funds, family offices, and high net worth individuals.

Mark to Market is an accounting practice that involves adjusting the value of an asset to reflect its current value

Committed Capital is the amount of money that the investors are contractually obligated to invest

Invested Capital is the amount of money actually invested in the fund by the investors

Claw Back is a payment by the general partner to the limited partners of money the general partner received from the successful sale of a portfolio company that they are required to pay to the limited partners as a result of the lack of success of other portfolio companies

Hurdle Rate is the preferred rate of return that the investors receive before the general partner receives their portion of the carry.

Carry is what a general partner receives as a performance payment after the invested capital and the hurdle rate is paid to the investors. after the investors are paid, the excess is split between the general partners and the investors. The formula is often 20% to the General Partners and 80% to the limited partners.

Waterfall dictates the distribution of money realized from the sale of the portfolio companies held by the fund. It is the profit distribution mechanism. There are two different types of waterfalls.

The American Waterfall distributes money on a deal by deal basis. The general partner receives its percentage of profit distribution after each company is sold. the distributions paid under the American Waterfall are subject to a claw back.
The European Waterfalldistributes money at the end of the investment period and after it is known exactly how all each of the portfolio companies performed. General Partners prefer the American Waterfall and investors prefer the European Waterfall.

Generally, it is not practical to attempt to value alternative investments and thus, the parties often co-own the investments. The party in whose name the investment is vested holds the Alt as a constructive trustee for the other party and is subject to all fiduciary duties until the investment is fully liquidated and distributed.

Most of the funds value their assets quarterly or annually. parties could elect to use those values to assign the investment in full to one party. However, the values used by the funds are not necessarily up to date or accurate. Many of the funds value the assets internally while others use independent third parties to complete the valuations. It should also be noted that during the first several years of the investment period, most Alts will show a negative value in that investments may have been made but have not generated a profit. This is referred to as the hockey stick effect.

The co-ownership of an alternative investment can involve a number of complications. In that many Alts are not fully funded on the purchase date, there are capital calls during the investment period. Capital is called in the first several years by the fund as investments are made. A family law judgment must address how to resolve a failure by one party to timely pay a capital call.

Conclusion

Hire the family law attorney that Orange County trusts. Call Minyard Morris at (949) 724-1111 or use our online submission form. Choosing the right Orange County family law attorney is more than just legal expertise – it’s about finding a supportive team to help you move on to the next chapter of your life.

Alternative Investments and Your Orange County Divorce FAQ

What is Separate Property in Characterization & Division of Complex Assets?

Although defining community property and separate property seems very straight forward, often the issues are extraordinarily complex. Separate property, as defined in California, is an asset owned prior to the date of marriage, acquired after the date of separation, or acquired after the date of marriage and prior to the date of separation by way of inheritance or gift as it is defined by the California Family Law Code. Community property is defined as an asset acquired after the date of marriage and prior to the date of separation, unless the asset was acquired by way of inheritance or gift as it is defined by California law. Income, rents, and dividends generated by separate property are separate property.

Community Property

Separate Property

What is Tracing in Characterization & Division of Complex Assets?

Tracing may be used to uncommingle bank or brokerage accounts and to trace separate funds used to purchase an asset that is titled in joint names. Tracing is also used relative to certain reimbursements to the separate property of one spouse or to the community.

Direct Tracing

What is Family Expense Tracing?

The second method of tracing is referred to as the Family Expense or Recapitulation method. This method may be used when the records that would prove the tracing do not exist to complete a direct tracing and the unavailability of the records is not the fault of the party seeking to trace his or her separate property.

The divorce court may conclude that the asset in question was purchased with separate funds, if the party can prove that at the time of the purchase transaction, there were no community funds available to make the purchase. This may be proven by demonstrating that the community expenses at the time of the transaction equaled or exceeded the community income, thus showing that there could not be community funds in existence.

Community expenses paid with funds from a commingled (containing community and separate funds) account are presumed to be paid with the community funds contained in the account, as opposed to one spouse’s separate funds contained in the same account. This rule is referred to as the “community expense presumption.” In other words, the community funds in a commingled account are used first, if the expenditure is for community expenses.

Family Expense (Recapitulation) Tracing

What is Involved in the Valuation of a Business in a Divorce Case?

The State Bar of California recognizes divorce as a specialized practice area. Representing clients in divorces that involve the valuation of business interests is even more specialized. Handling these matters requires a working knowledge of family law valuation principles, taxation, compensation issues, accounting principles, general foundational business knowledge, and the complex and conflicting divorce valuation, case law, and divorce litigation practicalities.

Representing a party in a divorce involving a business interest requires the retention of a divorce business valuation expert. They can be invaluable in negotiation and reaching a settlement, as experts often collaborate to reconcile differences in their findings and opinions. In many cases the divorce court will actually order the accountants to meet and confer long before the trial to attempt to resolve their differences.

Initial Characterization of Business

Asset Based Approach

Income Based Approach

What is Direct Tracing?

The Direct Tracing Method is the favored method of tracing. Direct tracing requires the transaction by transaction tracing of funds from a separate bank account or source into the purchase transaction. The separate funds must be shown to have been present in the bank account on the date when the purchase transaction occurred. There may be additional factors that come into play for the tracing to be successful. If separate funds were transferred into a community account prior to the purchase transaction, each transaction occurring between the deposit and the subject transaction must be analyzed. Specific detailed tracing requirements must be met.

For example, if a husband was attempting to trace $100,000 into a real estate purchase escrow account the tracing exercise could look like the steps set fourth below. The documents must show the existence of the $100,000 in husband’s separate account, the transfer of the funds into the joint account, and the transfer of the funds from the joint account into the escrow. On the date the $100,000 was transferred out of the joint account into the escrow, there must have been at least $100,000 of separate funds in the account, and the amount of separate funds must not have dropped below $100,000 between the date the husband made the transfer into the joint account, and the date of the transfer of the funds into the escrow. If the husband’s separate funds had dropped below the $100,000 level, the maximum amount that the husband could have traced would have been the remaining portion of the $100,000.

Direct Tracing Example

What Factors Do the Courts Analyze in Characterizing and Valuing Retirement Plans?

California divorce courts characterize and value retirement plans in a divorce based upon these and other factors depending on the details of each specific plan:

Type of plan;
Increase in plan value during the marriage;
Contributions to the plan during the marriage;
Specific contractual terms of the plan;
Performance of plan assets;
Age of the employee;
Years of employment before and after the marriage;
First possible retirement date; and
Survivorship options

California divorce courts generally allocate retirement plan benefits between separate property and community property according to when the benefits were earned. Benefits “earned” during the marriage (after the date of marriage and before the date of separation) are generally characterized by divorce courts as community property. Benefits “earned” before the date of marriage or after the date of separation are generally characterized as separate property. Complications may occur relative to dividing the earnings of the plan assets, when records are missing, when valuing a defined benefit plan and when drafting a Qualified Domestic Relations Order.

Two Basic Types of Retirement Plans

What Factors Does a Family Law Court Analyze in Determining the Characterization of Equity and Reimbursements Relative to Real Property?

California family law courts allocate the increase in equity in real property during the marriage to the community and/or the separate property of the parties based on a number of factors:

Changes in title
Date of acquisition
Source of funds used for acquisition, improvements and/or principal payments on a loan
Increase in value
Refinancing

Real Property Issues and Factors

Is There More Than One Type of Tracing?

There are two basic types of tracing:

Direct Tracing Method (mechanical tracing)
Family Expense (Recapitulation) Method

Tracing can be used to benefit either the separate property of one spouse or the community. Tracing can be very expensive and a party generally will not know if the tracing will be successful until after it is complete.

The court has the authority to allow tracing that does not totally comply with the traditional tracing rules so long as it does not rely on speculation and does not violate any other family law principles.

Is a Trial in a Divorce Case Similar to a Trial in Other Areas of Law?

Family law is made more complex than is generally thought because the courts follow the Evidence Code and the Code of Civil Procedure.

A trial in a divorce case is not dissimilar to a trial in other civil or business litigation with the exception that divorce cases do not involve a jury. The California Code of Civil Procedure and the Evidence Code must be followed. Trials may be very complex proceedings that are often lost due to a lack of understanding of procedural rules or the rules of evidence.

Evidence, Presumptions and Privileges

Is Tax Relevant to a Divorce Case?

Tax issues cannot be ignored. Often, tax issues are not identified until it is too late to manage or structure around them. Tax is yet another area of sophistication that must be addressed in a divorce. Tax plays a role in many, if not most, divorce cases. Divorces involve income and assets that frequently have tax related issues.

Tax issues may impact the actual values of many asset categories and decisions as to whether an asset is desirable to a party. The following issues and assets should be analyzed early in the divorce.

Tax rules and regulations must be strictly adhered to in order to avoid additional tax, penalties, and interest. The Internal Revenue Code (IRC) is a minefield in enemy territory, but the IRC provides a map detailing the exact location of the explosives. Unless you are familiar with the IRC, you run the risk of unexpected and costly surprises.

Tax Issues

Tax Issues in Family Law

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