If you own an interest in a small business, whether you are a sole proprietor, a partner in a partnership or a shareholder in a closely held corporation, Estate Planning can get complicated fast. Indeed, if a substantial part of your estate is a profit making business of significant value, there is seldom a "simple" Estate Plan. By definition, you need to plan carefully both at the business level and personal level. The death of the sole or part owner of a small business is likely to seriously disrupt that business. If no planning has been done, the disruption can be catastrophic, sometimes even resulting in the failure of a sound business. Simply stated, insuring the smooth succession of your business requires planning. It is important that you coordinate your planning efforts with an experienced Estate Planner with strong business and tax experience.

AVOIDING PROBATE

It's often disastrous for a small business to become enmeshed in Probate. Because the Probate Court will have jurisdiction over the decedent's interest in the business, the Court's intervention may tie up business operations. It can be burdensome, even disruptive, to have to seek a Probate Court's approval for business decisions that effect the decedent's interest in the business.

Revocable Living Trust. For individually owned or shared ownership businesses, transferring ownership of the business into a Living Trust is normally the best probate avoidance device. However, any partnership agreement, corporate bylaws or shareholders' agreement should specifically permit each owner to transfer the interest to a living trust. If the document does not provide for this, it should be amended or revised so that it does. Then, each owner creates a living trust, consistent with any requirements of the partnership agreement and transfers their respective interest to the trust. The trust then works like any other probate avoidance Living Trust.

SUCCESSION FOR INDIVIDUAL OWNERSHIP

It is rarely desirable to simply close down or sell a solely-owned business immediately on the death of its owner, unless it is a one-person service business. Even if your beneficiaries do not want to run the business over the long term, you will want them to have some flexibility in the timing of the sale – which means the business must be capable of continuing in a profitable fashion for a while.

Written Agreement with Employees. One way to achieve short-term continuity of business succession is for key employees, the owner and beneficiaries to agree in writing that the employees will stay around and continue to run the business for a period of time after the owners death or disability, perhaps in exchange for a small portion of the eventual sale proceeds. Incorporate. Another way to accomplish continuity of business succession is to incorporate the business and make the key employees officers of the corporation and minority stockholders

SUCCESSION OF A CLOSELY HELD BUSINESS

The closely held business offers estate and business planners some of the most difficult problems and most significant planning opportunities on behalf of their clients. Frequently, the closely help business is the client's most substantial single asset, as well as one of the most illiquid, threatening to put the estate in a vise of high estate valuation (and, hence, tax liability) and lack of realistic market to sell the business interest. The patent time pressures on an estate to sell a business interest often turns the liquidation into a "fire sale," which will seldom permit the realization of proceeds even approaching the true value under a more orderly marketing approach. This pressure, when combined with the understandable damage done to any business upon the loss of a key manager usually renders unplanned postmortem liquidation an unacceptable alternative to advance planning.

The Buy/Sell Agreement

Perhaps the most frequently utilized estate planning tool for the closely held business, but also under-analyzed, is the "Buy/Sell Agreement." The business entity may be in a partnership or a corporation, and the owners may be partners or shareholders. The buy/sell agreement may be used to ensure that a business entity will continue without interruption after the death of an owner, and to provide liquidity to a deceased owner's estate. However, Buy/Sell Agreements can also be used to provide for lifetime needs. For example, an agreement can provide for the purchase of a business interest in the event of the disability or retirement of an owner, as well as the owner's death. There are two principal types of Buy/Sell Agreements, (1) Cross-purchase Agreements and (2) Entity agreements. In a Cross-purchase agreement, the individual owners agree to purchase the deceased owner's share of the business. In an Entity Agreement, the business entity agrees to purchase the deceased owner's interest.

Functions of the Buy/Sell Agreement

Typically, a Buy/Sell Agreement is an arrangement by which the owners of a business entity agree to purchase the interest of a withdrawing or deceased owner of the same entity. However, the term "Buy/Sell Agreement" covers a broad array of contractual arrangements between the owners of closely held business, dealing with a multitude of business planning issues unrelated to the agreements to purchase or sell business interests that are implied by the name. Most Buy/Sell Agreements address three fundamental issues for the deceased or withdrawing owner: 1) defines the ownership interests, 2) determines the value of the ownership interest, and 3) provides a market for the ownership interest.

Identity of Ownership. Traditionally, the Buy/Sell Agreement will restrict lifetime and death transfers of ownership interests to assure a retention of control with the ownership group and to prevent the admission of new owners who either might introduce dissension or have business goals inconsistent to those of the original owners

Determining the Value of the Deceased Owner's Interest. To get all parties to agree on a fair method to determine the sale price, after an owner's death, can be problematic. To forestall complications, it is better for co-owners of a business to agree in advance of an owner's death how interests in the business are to be valued.

Payment for the Deceased Owner's Interest. Closely held business interests are often highly illiquid. The Buy/Sell Agreement permits each of the participants in the closely held business to create a market for his interest on the occurrence of specified events, including death, disability, retirement, or other specified circumstances. The, Buy/Sell Agreement represents an artificial marketplace for the business and establishes a market price for it.

Life insurance: Buy/Sell Agreements are often funded by life insurance policies. Life insurance is well suited to fund Buy/Sell Agreements, because it will ensure that the purchaser or purchasers will have the funds to purchase the deceased owner's interest, and that the deceased owner's estate will receive prompt payment.

Installment Sales: The Buy/Sell Agreement may provide, after establishment of a value for the purchased interest, that the purchasers are entitled to execute promissory notes for a set percentage of the purchase and defer payment over a period of years. The seller, in effect, becomes the funding source by surrendering equity for creditor participation in the business.

Third Party Borrowing: The Buy/Sell Agreement may provide merely that the purchase price will be payable in full on the date of closing. This provision in most cases contemplates that the purchaser will have the opportunity to arrange to borrow funds from third party lenders to satisfy the cash obligation.

 

NOTE: When incorporating your business interest into your Estate Plan it is important to seek the advise of an Estate Planning Attorney with both Business and tax planning experience and qualifications.