You have probably heard about using a will or other estate planning tool to protect your family, but what about your business? Small businesses rely heavily on their owners, and the unexpected death of a business partner could leave a key role unfilled. Without a succession plan in place stating who should take over, the business may be at risk of collapse. This could in turn mean that the owner's heirs will not have a valuable business to inherit. To ensure a smooth transition, you must have a succession plan in place.
As a general rule, your business interests are part of your estate. You can include them in your will, trust, or other estate planning documents. You may choose to leave your business to specific heirs or to have your business divided as part of your total estate. Exactly how it happens depends on the type of business.
An unincorporated sole proprietorship dissolves upon the death of the owner. The business's cash, inventory, and other assets are the owner's personal property and become part of the owner's estate just like their other personal effects. There is no separate business to pass on.
If you wish to leave your business to an heir to continue running it, you can include this in your succession plan. The process would be similar to a sale to another sole proprietor. Your heir would receive the business assets, including its contracts and intellectual property, but it would technically be a new business entity.
What happens to a partnership upon the death of a partner depends on the partnership agreement and whether the deceased owner or owners owned a majority interest. The three general options include the following:
The typical rule is that if a majority of the partnership changes hands within a year through death, sale, or other partnership changes, then the partnership is technically dissolved. However, the partnership agreement can specify that the partnership will continue as a new partnership.
When the partnership agreement is silent, which option is used by default depends on the state.
Limited liability companies (LLCs) function similarly to sole proprietorships if there was one owner and partnerships if there were multiple owners. For LLCs with multiple owners, the LLC operating agreement will control what happens if a business owner dies. Like partnerships, this could include dissolving the LLC or the deceased owner's estate taking over the interest in the LLC.
Both S corporations and C corporations are fully separate legal entities from their owners. When an owner dies, the corporation continues and the owner's shares in the corporation become part of their estate. The heirs who receive those shares obtain all dividends, ownership, and voting rights granted by those shares.
Some closely held corporations use a buy back agreement to ensure continuity of ownership. In a buy back agreement, when a shareholder dies the corporation buys their shares at a predetermined price. The proceeds go to the estate, but the heirs do not continue as owners.
All owners of small businesses must consider estate taxes in their succession plan. Estate taxes vary based on the value of the business and the overall size of the owner's estate including their other assets. Both the federal and state government may impose an estate tax.
The biggest problem for many family-owned businesses is that most of their net worth is tied up in the business. With federal estate tax rates as high as 40 percent, these families are often forced to sell their business to pay the taxes even though they want to continue to run it. To avoid this, estate tax planning should also be a part of the succession plan.
The first step in a succession plan is keeping the business going between the time of an owner's passing and the completion of the transfer of ownership and other needed transition steps. While this will likely be a difficult time for everyone involved in the business, there must be as little interruption to operations as possible.
If customer orders are not fulfilled or vendors are not paid, the business may lose the relationships it has built up over the years. In addition, customers will be wondering if the business will continue at the same level of service without the owner, and keeping things as close to normal as possible will reassure them.
The goals at this stage are continuity and avoiding power struggles. You need to make sure someone will take charge without having people fighting over who this should be. Ideally, this should be a co-owner or trusted manager who is already familiar with the roles the deceased owner played. It is not ideal to have an heir who was not already playing a management role to jump right in because they may not be familiar with the business or be able to gain the trust of the employees.
Your operating agreement and employee handbook should spell out who takes over in the absence of key individuals. In addition to providing clarity to everyone working for the business, it helps those who will be asked to step up to be mentally prepared for the additional responsibilities.
Whether you want to see your business as part of your heirs' inheritance or have them continue running it sets the stage for the remainder of your succession plan. In addition to your own preferences, you must make sure that your heirs are ready, willing, and able to take over before passing on the responsibility of running the business. This requires a heart-to-heart talk to find out if their goals and life priorities match your own.
The final thing you need to think about is who should be in charge of your business going forward. If you want a minority owner or non-owner manager to take over, it is recommended you put a buyout agreement in place that allows them to purchase your interest from your heirs. This could include a cash price or a royalty paid to your heirs for a certain number of years.
If you want to have an heir take over, you should ensure that they have the education, experience, and business acumen to do so successfully. If you are near retirement and nearly ready to hand over the reins anyway, this is relatively simple. If your chosen heir is not ready yet, you may need an intermediate plan that has a trusted advisor taking over operations until your heir is ready to take over.
To meet your goals, there are a number of succession planning tools that you can use.
You can find these and other succession planning tools in our legal document center. As a good succession plan covers many different aspects, both legal and non-legal, a complete succession plan will contain a number of different documents that you should keep together in a safe place just as you would with your personal estate planning documents.