As a business owner, you understand the importance of protecting your business from common threats such natural disasters, theft, and fire. That’s why you purchase insurance –to compensate you in the event of a loss caused by a covered event. Have you considered though what would happen to the business if something happened to you? Not only could your business suffer considerable economic losses in your absence, but the entire business could go under without you at the helm. Incorporating business succession planning into your overall estate plan helps to ensure that your business continues to successfully operate in the wake of your sudden death or incapacitation.
Because every business is unique, no two business succession plans are the same. Nevertheless, there are some common goals and objectives that most business owners try to achieve with their plan, including:
- Designating of someone to take over the immediate day to day control of your business if you are incapacitated tomorrow because of a catastrophic accident or debilitating illness.
- Ensuring that everyone impacted, including employees, business associates, and family, is prepared to accept your designated replacement.
- Preparing the necessary legal documents to ensure that your designated replacement will have the necessary legal authority to step in and take over.
- Making sure that your family will continue to benefit financially from the success of the business in the event of your incapacity.
- Putting a plan in place for someone to take over permanently, or to sell the business, in the event of your death.
- Keeping the business out of probate if possible.
- Devising a plan to value your interest in the business at the time of your death.
- Preparing the next generation to take over the business if you plan to keep it in the family.
- Creating the most advantageous legal structure for the business.
- Anticipating the tax implications for the business in the event of your death.
- Making sure sufficient liquid assets are available to cover any tax debt that might be owed when you die.
As the owner of a small business, planning for the possibility of your own incapacity should be an essential component of your overall estate plan. The reality is that most small businesses cannot function for long without a strong leader. Moreover, the person you designate to step in for you must have the proper legal authority to act on your behalf. Although you may not wish to think about the possibility, you could be incapacitated tomorrow as a result of a catastrophic motor vehicle accident. In the absence of a well thought out incapacity plan, no one would have the legal authority to negotiate contracts for the purchase of supplies nor for the sale of products. Banks, suppliers, customers, government agencies would all be unwilling to continue working with your business. Customers/clients would become reluctant to continue doing business with your business given the uncertainty of the leadership. Including an incapacity plan in your comprehensive estate plan prevents such an outcome.
Management continuity is crucial for a small business. Small business owners often make the mistake of assuming that an adult child or senior employee is willing to take over the management of the business if necessary, only to find out too late that their assumption was wrong. Of equal importance is ensuring that the individual you designate to step in and take over has the requisite legal authority and practical capacity to do so. A well thought out succession plan will ensure that a successor is ready to step up and take over as smoothly as possible should the need arise.
Liquidity refers to cash assets or assets that can be readily converted to cash. Small business often lacks sufficient liquidity, particularly when they are relatively young businesses or when they are farm/ranch operations. All too often, the business’ assets are tied up in things such as equipment, supplies, merchandise, or livestock that cannot easily be converted to cash. In the event of your death, however, your entire estate could be subject to federal gift and estate taxes which are calculated based on the value of your estate, without regard to whether your estate assets are liquid or non-liquid assets. If your business lacks sufficient liquid assets to pay any tax due, critical assets might have to be sold to pay the tax, putting the entire business at risk
When you should start thinking about transitioning ownership of the business depends, to a great extent, on whether you plan to pass it down to the next generation, sell your interest to a partner, or sell to a third party. If you plan to pass the business down to the next generation it is really never too soon to get started. On the other hand, if the business is to be sold upon your death or incapacity, you should be planning for that now to ensure that your loved ones receive the fair market value of your interest in the business when the time comes to sell it, but you won’t actually start transitioning ownership now.
One popular method used to transfer ownership of your business from one generation to the next is to create a Family Limited Partnership (FLP). An FLP allows you to transfer your legal interest in the business to the next generation slowly, over time, while maintaining control over the day to day management of the operation until such time as you are ready to retire. In addition, you may be able to gain tax advantages by using an FLP to transfer interest in your business to future generations.
For small business owners that do not plan to pass the business down to the next generation, it is a good idea to plan ahead for the sale of the business in the event of your death or capacity. One option is to enter into a Buy-Sell agreement. A Buy-Sell agreement guarantees that you (or your loved ones) will receive the fair market value of your interest in the business in the event you, or your surviving loved ones, must sell it at a later date. In essence, a Buy-Sell agreement is a binding agreement between you and someone who agrees to purchase your interest in the business in the future for a pre-determined price or using a fixed method of determining the fair market value at the time of the sale.