Who Inherits Your Business? Think About Succession Planning …
Death and Taxes
Let’s face it. Nobody likes talking about their own mortality. Its not a happy subject, nor is it easily brought up. However as a small business owner, you owe it to yourself (and your loved ones) to ask: What happens to my business when I die? What happens to the business if one of my business partners dies?
To complicate things, death isn’t the only issue that can affect a business owner or a partner. What happens if someone retires? Or becomes disabled? Or gets divorced? Its tempting to put off such planning. Morbid as it may be to dwell on such topics, but advance planning can save money, time and heartache later down the road.
Why do you do what you do? I frequently hear small business owners attribute their decision to start a business in order “to leave a legacy for their family.” Even business owners without any immediate family, may want to allow their employees to inherit the business or leave the business to a specific charity. Almost all business owners want to see the fruits of their hard work continue when they are no longer involved.
Can your business survive death, retirement or divorce?
Sadly, without proper succession planning, it’s very unlikely your business will transform the way you wish. Furthermore, lack of planning will make it difficult to efficiently handle a retirement, incapacity or divorce. If one doesn’t ask themselves these important questions — and take the proper steps to ensure their wishes are fulfilled now — the consequences can be devastating later.
For death or incapacity, the general rule is the following: Your holdings in any and all business entities revert to your Estate, after your Estate has been settled. So who exactly is your Estate? Determining your Estate is often a very complicated analysis of a Will (if one exists or isn’t disputed) or state intestacy law (if no Will exists or can be found). Even under the best of circumstances, this process can take weeks and usually involves a probate court.
For retirement, the general rule is: Unless the partners have agreed to something in writing beforehand, there is no “default” law or rule to hold against the remaining partner(s) or retiring partner. It’s pure negotiations, between all the owners, remaining partners and retiring partner alike. Keep in mind this situation can get messy as partners may disagree, have separate agendas, differences in bargaining power and bad blood. Beware of “hidden provisions” in the Operating Agreement or Bylaws that can tilt negotiations in the favor of either party.
Finally, for divorce, the general rule is: Anything goes. Its a free for all! Unless you have a well-drafted buy/sell agreement (for a corporation) or appropriate provisions in your Operating Agreement (for a LLC), a company can do little to prevent family court from carving out a “spousal share” of the business and seeing a partner’s ex-spouse take ownership in the business. The only sure-fire way to prevent an ex-spouse from joining the partnership, is having a buy/sell agreement or Operating Agreement force such an ex-spouse to sell his or her ownership (if they are awarded it) back to the company (or cross-sale back to the remaining partners).
Where there’s a Will, is there a Way?
A Will is a fantastic way to help ensure your wishes are met upon your death. However, Wills are not foolproof. They can be contested. They can be lost. Wills (usually) need to be approved by a probate court and it can mean the business languishes as leadership is sorted out. Probate can potentially take a year or more, depending on the nature of the debts, assets and claims made upon your estate. How will your business survive this transition period?
A Will only addresses YOUR estate upon YOUR death. A Will is NOT a great way to force all partners into an agreement for the business. Just because you do a Will one way, doesn’t mean your partner’s Will is the same as yours. Furthermore, there’s no way to ensure your partner’s Will will actually be interpreted and enforced the way you had hoped.
DO NOT rely on the state to properly follow your Will!
What you do NOT want to do, is assume the state will do the right thing if you have no Will. DO NOT assume the state will do the right thing! There is absolutely no guarantee the state will follow your Will. Intestacy law is very complicated and it’s not always clear who gets what. Outstanding debts and obligations will have to be resolved in probate, before ANYONE gets assets from an estate — especially a business.
Also, consider those individuals you mention in your Will. When I talk to business leaders about Wills, they usually say something like: “I already set that up. My daughter/son going to get everything, so they will automatically get the business. There’s nothing for me to do.” Wrong! Are they prepared to take your place? Do they know how to contribute? Are they even in a location conducive to participating in your business, after your death or incapacity? Do they get along with your existing partners? You cannot simply ‘Will” these issues away (pun intended).
There are better ways . . .
It pays (literally) to plan ahead with succession planning!
Does the whole idea of succession make you slightly queasy? Well, there is an easier way. If you have partners, you all owe it to each other to discuss these issues now and put a plan in place to address everything: Death, incapacity, retirement and divorce. Ask yourselves some hard questions and seek the advice of your banker, lawyer and CPA. Those questions include:
- If a partner dies or becomes incapacitated, do you want to be doing business with his or her family?
- How much should your (or your partners’) estates be paid, upon one of your deaths?
- How much will the business be set-back, if you or your business partner dies? How would it recover?
- Are their key loans, notes or mortgages that would be called upon the death of you or your business partner?
- If a partner wants to retire, how does that partner leave amicably? Is there a valuation predetermined for the business? Can the business pay the retiring partner a lump-sum or installment payments over time?
- What happens if a partner divorces? Is it okay to have the ex-spouse as a partner? Or, will the business be required (or have the option) to buy out the ex-spouse? Or, will the ex-spouse’s ownership revert to non-voting?
Depending on how you answered those questions above, you may wish to consider one or more of the following:
- Key man (or “key life”) insurance. This is a form of “life insurance” for the principals of a business, ensuring the company gets an injection of cash to acquire a deceased partner’s share from an estate or to otherwise make it possible to hire a replacement.
- Invoke a Buy/Sell Agreement. This is a “contract” between the partners of a company (usually a corporation, C-Corp or S-Corp) that is “automatically triggered” upon certain events such as a death, incapacity, retirement or divorce. For example, it could dictate that the surviving partners have the option and right, but not the duty, to acquire the deceased partner’s ownership from the estate within a certain period of time. Alternatively, it could relegate estate owners to “non-voting” ownership.
- [Unit or Share] Restriction Agreement. This is another “contract” between the partners, and maintains restrictions on how ownership may be devised, transferred or conveyed. This document, along with a spousal consent form, can help prevent ownership from transferring to a spouse in a divorce.
- Employee Stock Ownership Plan (ESOP). This is a sophisticated option available to business owners who basically “sell their ownership to a properly prepared trust,” which in turn makes annual contributions to the accounts of the employees. This is a beneficial way to transfer the ownership of a company from its primary owner or partners to employees.
If the long-term success of your business is a concern, then you owe it to your business, your partners and any beneficiaries of your estate to talk to a professional and institute a succession plan that fits your particular needs and desires. It pays to consider these factors now, while you are paying to create the right formation documents for your new business.
Looking for more information? We would be more than happy to have you as our guest at the Bank of Albuquerque: The Private Bank’s Business Succession Planning Breakfast. Feel free to bring guests. RSVP to Veronica Gutierrez ([email protected]). Be sure to mention that you are a client of Law 4 Small Business P.C. (L4SB). It happens Wednesday, September 16 2015, from 8:30am to 10am at the Marriot Uptown. Special guest, David Coggins from Ash Brokerage will discuss five compelling reasons to plan for ownership and management succession. The goal of this discussion is to give teach you ideas on how to start the discussion, plus the resources needed to take action.
Law 4 Small Business. A little law now can save a lot later.