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Summary

You can either plan for a continuation of your business after death by transferring all or part of the business to your heirs or selling the business during your lifetime, or after your death. The type of plans that need to be made differ depending on whether the business is a Sole Proprietorship, Partnership or Corporation/Limited Liability Company (LLC).

While you make plans, think about what should happen if the business has to be liquidated because there is no appropriate manager available or if there is no buyer.

Also consider writing an Ethical Business Will which tells your successors about the history of the business and any values you want to pass on.

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Estate Planning

Sole Proprietor

If family is to continue the business

A business may be transferred to a capable family member as a gift during your lifetime or through provisions in your Will and/or Trust, or by a sale provided through a prearranged purchase agreement effective at death.

If there will be a sale, either the beneficiary needs cash or you need to make arrangements for the beneficiary to pay the purchase price over time. When setting a price, anticipate a decrease in income while the business adjusts to your no longer being there.

Consider writing a Business Ethical Will to help your heirs understand and continue your vision for the business. (See Business Ethical Will).

Buy/Sell agreement with a key employee

A buy-sell agreement can be between a key employee and a sole proprietor. The agreement obligates the key employee to purchase the interest of the deceased owner. Such an agreement :

  • Creates a guaranteed market for your business interest.
  • Keeps your heirs from interfering.
  • Establishes the value of the business for estate tax purposes.
  • Can provide liquidity for your heirs.

Be careful.  Buy/sell agreements can have vastly different provisions.  One may look like another, but there's a lot to consider, including provisions dealing with disability.

Sale to a new owner

The death or disability of an owner can be fatal to a business. Your skills, reputation and management ability help to make the business successful. Without these human life values the business may only be worth the liquidation value of the tangible assets, rather than the value of a going business with goodwill.

If your business is dependent on you, you are likely to maximize value for your beneficiaries if you sell while you are alive. An alternative is a sale arrangement which takes effect at your demise. You get to run and own the business until then -- subject only to whatever limitations are written into the agreement.

Consider writing a Business Ethical Will for the new owner. (See Business Ethical Will).

A Partnership

  • Unless there is a written agreement to the contrary, as a general matter, the death of a partner automatically dissolves the firm.
  • In the absence of an agreement to the contrary, surviving partners have no right to buy the deceased's partnership interest.
  • If the deceased was in debt to the partnership, the estate must settle the account in full and in cash.
  • The surviving partners have exclusive possession of firm property but no right to carry on the business.
  • If the business is continued, the surviving partners must share all profits with the deceased's estate and are liable for all losses.
  • The surviving partners must liquidate the business, pay off partnership debts, make an accounting to the deceased's estate, and divide the proceeds with the estate.

Alternative arrangements to consider:

  • Enter into a buy/sell arrangement where your interest is sold to your partner, or vice versa. Include how the price is determined, as well as how it will be paid. Perhaps life insurance can be purchased to fund the purchase price, or at least to act as a down payment.
  • Reorganize the business with your heirs or with a new partner picked by you or your heirs stepping in to your shoes. The arrangement, and your choice, has to be acceptable to your partners.
  • Require that the company be liquidated on the death of a partner.
    • The resulting funds will likely reflect a low price -- with no consideration for goodwill.
    • All surviving partners and employees will be out of a job.

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A Corporation Or Limited Liability Company

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.
  • 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.
  • 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.
  • 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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If The Business Is To Be Sold Or Liquidated

If you decide that the business should be sold or liquidated after your demise, or if future management is not available, and there is no buyer, then the business must be liquidated.

If a liquidation will happen after your demise:

  • Who is the best person to handle the liquidation? There are consultants who specialize in liquidations. Interview several of them. Check references from people who have used their services. Double check the extent to which the liquidators put their interests ahead of your own.
  • Prepare guidance for the liquidator. After all, who knows the business and how to maximize the value of your assets better than you?
  • Consider whether cash will be needed to offset the difference between the business' going-concern value and its auction-block liquidation value? Where will the cash come from?