What Plans Should Be Made For What Happens To The Business After An Owner's Death?
A Corporation Or Limited Liability Company
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A closely held corporation or limited liability company can continue in business despite the death of a shareholder who has been active in the operation. However, the interests of the heirs of the deceased almost inevitably come in conflict with the interests of the surviving associates.
If you leave your heirs a majority interest:
- They may choose to become personally involved in management in order to receive income. Or, they may choose to remain inactive, elect a new board of directors and force the company to pay dividends.
- If you leave your interest to more than one heir, they need to act together to retain their majority interest. Otherwise, each of them become minority shareholders. This problem can be alleviated if you leave your interest to a trust or other entity.
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Surviving stockholders may lose a voice in management and possibly their jobs.
If the heirs have a minority interest and are not employed by the surviving associates, their only means of receiving an income from the corporation will be through dividends. But, the surviving stockholders want business growth through reinvestment of profits. They can not afford to have much, if anything, paid as "double-taxed" dividends. This will result in a dissatisfied group of minority stockholder who want immediate withdrawal of profits to provide income and who may become an intolerable nuisance factor.
Alternative arrangements to consider:
Retention of stock by the heirs: As described above, this likely leaves a situation in which no one is happy. Of course, it depends on the heirs. According to Fortune Cookie wisdom: "A father who depends on his son is either wise or foolish, depending on the son."
Sale of stock by your heirs: A sale of stock by your heirs can either be arranged ahead or time or after death.
- If arranged while you are alive, the agreement is known as a Buy/Sell Agreement if it is between shareholders, or a Redemption if the entity is to purchase the shares. Upon death of any of the shareholders, the heirs receive a fair price that was either predetermined as a set amount, or can be set by a formula that is already in place. The agreement benefits all shareholders to the same extent that it benefits you since there is no way to know who will die in what order. Keep in mind that just because an agreement is in place, doesn't mean that it will be followed. Funding an agreement with life insurance as described in the next paragraph helps to satisfy your concern that the business will continue and your heirs will be protected.
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If arranged afterward, it is difficult for heirs to set a reasonable price for their shares. If you have a minority interest, the price they'll receive is likely to be less than a proportionate share of the full value.
Even if they can agree on a price, unless there is available cash, or life insurance to provide the cash, your heirs will probably have to accept some type of installment payments.
Life insurance is a good means of guaranteeing cash to fund a purchase.
- Life Insurance should be applied for on the life of each shareholder.
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Life Insurance should be applied for before preparing the agreement in case you can't get it, or your premium is rated much higher than a healthy person your age.
A lawyer will advise about which is the best arrangement to use and potential tax consequences. A lawyer will also prepare the necessary documents.
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