Exit and Business Succession Planning: The Death of an Owner

Estate Planning

Unplanned Inheritance

When an owner dies, without specific planning, their business interest becomes a part of their estate. Without a will or directive, the assets in the estate will be transferred in probate according to state law. This transfer could also result in tax consequences depending on the value of the estate.  As far as exit planning goes, this may work adequately for a family run business where the spouse or a single heir is sufficiently involved in the business, wants to continue to run the business, and can effectively run the business. However, there are a lot of contingencies which may result in havoc. As one example, what if there are multiple heirs who do not agree on the way to run the business, or who do not want to run the business? In short, there are a lot of potential problems with this unplanned process.

Planned Inheritance

The next step up is that an owner, with some estate planning, can use various instruments such as a will or a trust to more specifically determine the disposition of the business ownership interest at death. This might include putting the interest into a trust for the benefit of family members while designating a trustee such as a spouse or qualified person who can exercise the voting rights of the ownership interest in a responsible manner. 

While almost always better than no estate planning, the estate plan does not always take into account the concurrent issues related to the survival and success of the business itself.  Often, estate planning by the owner is a top down approach concerned with minimizing taxes while trying to provide for heirs, and the business interest is treated as a simple asset. The reality is the business interest, and the business itself, is a complex asset dependent on a whole host of factors, including, whether the heirs can successfully work together as owners of the business, whether the business’s success was dependent on the deceased owner, whether there is a qualified management team that will stay with the business after an owner’s death, and many other issues.  In short, even with complicated estate planning, the plan has to be directly related to the business succession plan for it to ultimately be successful.

An owner cannot get into the trap of thinking of the business after their death as if it will be valued after their death the same way it is valued during their lifetime and their involvement. Implicitly, the value of the business asset itself, and whether it will provide a benefit or a burden to heirs, is directly tied to the stable control and management of the business. Concurrently with the estate planning, an owner must engage in business succession planning.  The ultimate goal is to have both the estate plan and the business succession plan compliment each other.  

In short, when a business is involved, the owner not only needs to consider how the benefit of what they have built will be allocated to heirs, they need to think about how the business value will survive their passing. Estate planning which involves business assets such as an ownership interest, has to look beyond the value of the business during the life of the owner, and look to how the estate planning and business planning will perpetuate the value of the business after their death.

Simple Business Succession Planning

If the owner has an unrelated partner who can take over for them, and perpetuate the business after the owner’s death, one way to address the death of the owner is to provide that the partner (or the business) has the right, or perhaps obligation, to buy the ownership interest from the owner after they die. This can solve two problems. First, the owner’s death does not result in the inadvertent transfer of a portion of the control of the company to the owner’s spouse or heirs who are often either uninterested or unqualified to run the business.  It is important to note that the introduction of a uninterested or unqualified owner can quickly create problems for the stability and value of the business. Second, the sale to the other partner liquidates the asset of the owner so that the heirs have something they can actually use to buy groceries and pay the mortgage.

While such a buy-out by a partner can still involve difficulties for the business, not the least of which may be cash flow to cover the purchase, planning and financial tools, such as life insurance on the owners, can help to mitigate the difficulties. Specifically, the business can be the beneficiary of life insurance on the owner who dies, and use that insurance to fund payment to the estate for the purchase of the owner’s interest.

In another situation, if the owners are spouses, and either spouse can continue to run the business effectively after the death of the other spouse, under some basic estate planning tools, the death of one spouse will generally result in the other spouse inheriting the decedent’s ownership interest. 

However, it is important to remember that the situations described, and situations like them, may work fairly well for the first owner’s death, but they do not address the fundamental issues of business succession in the long run.  For example, the basic buy-out or estate planning suggested does not address the second owner’s death. Further, we are only talking about death in specific examples.  This post does not attempt to address disability, incapacity, divorce, bankruptcy, or other potential situations.

Going Beyond a First Death

If the owner is the only owner, either because they started that way or became the sole owner after a partner’s death, the sole owner has to be prepared to address more complicated issues. Will the business close after their death? Will the owner try to sell the business before their death?  Will the business be passed along to qualified person, whether an heir, a key employee, or someone else?

Dissolution or Closing Down

In the situation of closing down, it is important to remember that there will likely be many issues and obligations that will have to be addressed to close the business down smoothly after an owner’s death. Usually, the last thing an owner wants to do is leave the problems of closing down a business to their family who is already grieving their loss. Without planning, substantial value in the business will simply be lost because of an owner’s death. In addition, the unplanned demise of a business can often cause the heirs a great deal of difficulty and problems which might otherwise be avoided.  Even in simple situations, some planning should be done to address the dissolution of a business on the death of an owner.

Planning for a Sale of the Business

In the situation of a sale, an owner has to have built something of value which exists independent of themselves. No buyer wants to buy a business, other than perhaps just the bare assets of the business (if there are any), that is dependent on a person who will no longer be there. A business owner thinking of sale needs to spend time working on building a business which exists independent of themselves with intrinsic value, enough that they can get a price that will take care of them and their family once the sale is complete.

Passing the Business On

If an owner desires to pass the business on to another, they must not only prepare for their own financial survival after they exist the business, they must make the business desirable for the new owner, and groom their successor(s) into the role they will take when they are gone. In short, the owner cannot merely designate a successor, the successor must designate themselves, and be able to do what is necessary to take over.

Conclusion

In each of these situations, the owner must be intentional about their goals and vision for themselves, and the business.  Along with being intentional, the owner must also be willing to take appropriate actions and make appropriate investments to grow the business and develop a succession plan.  The successful succession of a business which maintains the value of the business and provides for heirs of a deceased owner requires a combination of intentional management and planning that involves various legal tools and documents that reinforce the plans.

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