While there is a basic understanding among small business people that incorporating a business will provide protection to the owner against personal liability, for many that is where the thinking about the importance of business structure stops. However, even for someone who is a sole owner of his or her incorporated business, thought must be given to what happens to the business upon the death of the owner.
If the stock or membership interests in the business are in the sole name of the owner, that stock or those membership interests must go through the probate process to be passed to any loved ones. That process takes between eight months to a year. During that time, the Personal Representative of the estate (“PR”) has the power to control the stock or membership interests in the business. That means they can vote the stock and take other business decisions to keep the business alive.
P roblems with this structure are obvious. What if the PR knows absolutely nothing about the business? Even if you as a business owner have no intention of having your business survive you, who will help to shut it down after you die? If the revenues suddenly come to a halt, who will pay the debts of the business and how? These questions are all too real and deserve the attention of the business owner now, prior to death.
The best approach for every small business owner is to create a plan for the business before you die and put it in place. Business owners must review their corporate structure and intentions with an attorney to create documentation allowing the business to go forward, whether or not the owner is deceased. Sometimes, the operating agreements of the business can be amended to address what happens when the owner dies, or a shareholder agreement or member agreement can make that clear. The will or living trust also can address the issues. Often, a buy-sell agreement is created to allow someone to purchase the business upon the death of the owner. No matter what form is used, unless the business owner takes action to address the issue of their death, the small business owner can put his or her family in jeopardy by taking no action at all.
For example, almost every small business has had to obtain bank, supplier or landlord financing at some point. Banks, suppliers and landlords are not likely to loan money to your small business within the first three years of business. They will demand some sort of personal guaranty. That personal guaranty you gave for your business loan can hurt your family when you die. If you die before you pay off the loan, the bank or supplier can attach the personal assets you have pledged to satisfy the loan. Without planning for what happens to the business when you die, your business could very well lose all revenue, default on its loans and result in the attachment of your and your family’s personal assets. Wasn’t protection against the seizure of personal assets the very reason you sought incorporation in the first place? Yes, but reality, especially when dealing with creditors, can upset all plans.
Additionally, disputes among family members can escalate after the small business owner dies unless the business owner addresses the issues prior to death.
Suppose you are the owner of a successful plumbing company that employs two of your five sons, both of whom want to make plumbing their career. If you die as the sole stockholder without a will and without a spouse, your ownership interests will go in equal shares to your five children. Did I mention that two of the five work in the business and three don’t care about it at all? Those three could very well sell the business out from under the two who want it to continue. Unless the business owner takes steps to figure out how to get the business to the two who want it and what to do about the three who don’t, the family is left with a terrible problem.
Taking this another step further, if you decide that the two children who want the business should get the stock in the business, shared equally, and the three who don’t want the business should instead get the cash value of the business shared equally, what will you use as the measure of valuation of the company? Who will value the business when you die? What standard will be used? And, if the appraisal of the business is such that payout to the three who do not want the business will handicap the cash flow of the business itself, you need to decide on what terms you intend for a cash payout to those children who do not want to be involved in the business, perhaps selecting payout over a term of years so that the cash flow of the business is not adversely impacted.
Most small businesses are so highly dependent on their owners, not only to keep the revenue flowing but to pay debts, that loss of that owner could lead to business bankruptcy.
The small business owner must look to sources of funds for the business after he or she dies. This is where insurance coverage purchased by the business on the life of the owner will help. Life insurance proceeds paid directly to the business will enable it to meet debt payments or finance any buy out of shareholders who do not want to continue in the business.
Business transition plans are very important. If your business has helped your family to survive, you must take steps now to ensure it will continue to do so after you die. That means figuring out who will run the business when you die, because a business needs a leader and decision-maker.
Is there someone in the family capable and willing to do the job? Is it someone on your staff you have been training? What is the incentive for the person to want to continue the business? Are you willing to part with a percentage of stock or membership interests to keep someone interested in continuing the business? All of these provisions and more need to be reduced to writing.
Many business owners are fortunate enough to have a second in command willing to take over running the business when they die. The time to discuss the terms and conditions of this transition is now, while you are still alive. Only by discussing the actual terms of a transition can you assist your business to survive.
I have seen so many small businesses fail after the death of an owner because there was no transition plan in place. Don’t let that happen to you. Protection your business now through creation of a transition plan will ensure protection of your loved ones later.
About the Author: Lyn Striegel is an attorney in private practice in Chesapeake Beach and Annapolis. Lyn has over thirty years experience in the fields of estate and financial planning and is the author of “Live Secure: Estate and Financial Planning for Women and the Men Who Love Them” (2013 ebook download available at LegalStriegel.com.). Nothing in this article constitutes specific legal or financial advice and readers are advised to consult their own counsel.