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Will Your Business Die When You Die?

| May 4, 2020 | Business, Business Formation & Planning, Estate Planning |

Small business owners face many challenges—especially in this day of COVID-19! But challenges are nothing new for these owners. Whether it is marketing, cash flow, taxes, governmental regulation, or dealing with employees, there are always obstacles and difficulties facing small business owners. Being able to deal with them effectively is one of the things that makes a successful small business thrive.

One challenge that is often neglected by small business owners is preparing for the death (or incapacity) of the owner. A simple question to an owner can make this point: Will your business die when you die? When we ask this question of clients who own small businesses, they often reply, “I don’t know.” That’s where business succession planning comes into play. With good counsel and by putting the right documents in place, a business owner can answer with confidence what will happen at the time of death.

To implement a business succession plan, there are several considerations. First, if the owner has a co-owner (or even a key employee who is not an owner), there should be a buy-sell agreement in place. This agreement sets out the terms for what happens when an owner dies. Usually, this type of agreement will provide that the surviving owner or a key employee may buy the shares of the deceased owner. By doing that, the deceased owner’s estate or heirs can receive the value of the shares and the surviving owner will not be forced into partnership with someone with which he or she may not wish to do business.

Here’s an example. John and Tom own a small insurance agency together. They never got around to setting up a buy-sell agreement, even though their lawyer encouraged them to do so. Both are married but neither owner’s spouse works in the business. Tom dies and in his Will he names his wife, Sally, as his sole beneficiary. Since there’s no buy-sell agreement, Sally is not compelled to sell Tom’s shares to John. She could continue to own the shares or she could sell them to someone else. Unfortunate for John, Sally and he have never gotten along and now he may have to be in business with her or he may have to negotiate a buy-out with her. Now Sally can set the terms of whether she will sell to John and if so, on what terms. If there had been a buy-sell agreement, this  never would have happened.

A well-drafted buy-sell agreement will address what happens to the shares or ownership interest of a deceased owner. It will also provide the terms of a buy-out. Often the agreement will determine a time frame for the buy-out, how the purchase price will be determined, and whether the buy-out is for cash or will be paid over time. These are all essential terms that are better made by the owners ahead of time rather than fighting over them after one owner dies. Some buy-sell agreements even incorporate life insurance so that there are easily accessible funds to accomplish the buy-out.

Another consideration when it comes to a business succession plan is what will have to happen in order to transfer the shares or ownership interest? For example, if the business is operated as a corporation , how are the shares owned? If they are owned solely in the name of the individual owners, a probate may be necessary in order to transfer the shares. However, if the owner has established a Revocable Living Trust and has assigned the shares into the Trust, then the shares can be transferred without the expense and delay caused by probate. The transfer of a small business at the death of an owner may be impacted by how long the transfer takes. If the company gets caught up in a probate (which in Florida can easily take over a year to complete), then the business may die before it can be transferred.

Another example may help to understand how this aspect of business succession works. Andrew is a dentist who runs his highly profitable dental practice through a professional association (which is a type of corporation). Andrew owns the shares of the association in his sole name. Andrew dies suddenly. He has a Last Will and Testament but not a Revocable Living Trust. Immediately after Andrew dies, one of his dental colleagues, Dr. Charles, approaches Andrew’s wife and says that he will buy the practice for a fair price but only if the sale can be closed within twenty days. Dr. Charles knows that the value of Andrew’s dental practice depends on a quick transfer because patients will look elsewhere very quickly. Andrew’s wife goes to a probate attorney and learns the bad news. The probate cannot be opened and moved along quickly enough to allow the quick sale. Sadly, if Andrew had held his stock i in a Revocable Living Trust, the sale could have been accomplished almost immediately.

Establishing a business succession plan can be complicated and should be done through an experienced estate planning attorney. This is not the type of planning that you want to do using some form that you printed off the Internet or through some legal services site. An experienced attorney can give the legal counsel that you need in order to best structure the terms and the necessary documentation to protect the company, the owners, and the owners’ heirs.

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