By Attorney Kelly Jesson
We previously wrote about the importance of keeping good business records in order to avoid personal liability for business debts. However, did you know that certain business records can act as estate planning tools?
Your interest in your business, whether an LLC interest or corporate stock, is personal property that you can leave to a family member when you pass away. Unfortunately, it will go through probate unless you transfer it to a trust or enter into a transfer-upon-death (TOD) or joint with rights of survivorship agreement with your heir. The court collects a fee based on the amount of personal property that goes through probate, so if your business is worth some money, you want to avoid this.
What if you have a business partner? Perhaps you don’t want to do business with his/her spouse or child if your partner passes away? That’s where an operating agreement or a shareholder’s agreement comes in handy—in either of these agreements, the owners can agree that if one of them passes away, the other will buy out their interest. This is helpful for the survivor, who will remain in control of the company, and this is helpful for the deceased owner’s family, who will get a sum of money. These agreements (also called buy-sell agreements) are oftentimes funded with life insurance, to ensure that there is liquid cash available to pay the family.
In either of these agreements, the owners can promise the other not to transfer their business interest to third parties while they’re alive, which is also helpful for control purposes. The parties can agree to buy the other out when other “triggering events” happen, such as a partner’s bankruptcy or divorce. You don’t want one of these events to cause the forced sale of all or part of the business. It is important to put a plan in place to prepare for the unexpected (that frequently happen).
If you or someone you know needs assistance putting an operating agreement or shareholder agreement in place, or incorporating their business into their estate plan, please give Jesson & Rains a call! We offer flat fee packages for these formation documents. We also offer flat fee annual plans that include preparing annual meeting notices and minutes, filing annual reports with the Secretary of State’s office, and other legal services. More information can be found here.
In North Carolina, generally, the answer to this question depends on (1) what type of business you own; (2) whether you have bylaws or an operating agreement; (3) whether you have a will; and (4) if you have an insolvent estate.
No matter what type of business, your interest in the business is an asset. Unless there’s a contract stating otherwise, it is an inheritable asset, meaning if you have a will, you can name who the interest passes down to, or if you do not have a will, the interest will pass to your heirs (spouse, children, etc.). If you want to pass your business interest to your son, who will run the family business, instead of it passing naturally to your spouse, you need to have a will drafted.
When the individual and the business entity are interwoven, like a sole proprietorship or a partnership, it is important to note that business debts are oftentimes personal and can cause your estate to be insolvent (leaving nothing for your family). This is an important reason to form a business entity separate from the individual. If your business is not healthy, it may cease to operate at your death and wipe out your estate.
If you have a contract with other members of the business, you can state what happens to your interest when you pass. This is one of the reasons why we urge people who are going into business with non-relatives to enter into operating agreements – do you really want to be working with your business owner’s spouse after the pass away? More importantly, what happens if the spouse has no interest in running the business? What if she wants to sell or have you buy her out? What if you cannot afford to do so? In addition to recommending our clients enter into operating agreements, we recommend that they incorporate buy/sell language into these agreements. Financial professionals can find inexpensive ways to fund these agreements so that a partner can afford to buy another out.
If you own stock in a corporation, that stock will be passed to your beneficiary or heirs just like any other property. While this is not a big deal if you own stock in AT&T, for example, it is a big deal if you own 90% of the shares of a small, family owned business. Again, maybe your business partner does not want to own the corporation with your spouse.
If it is your wishes to continue your business when you pass, and your family is onboard, it may be a good idea to put your business interest in the name of a revocable trust. This way, your business interest stays out of your estate when you pass away and the trustee can manage your business interests better than the executor can. Many attorneys will recommend to executors to liquidate business assets because there is too much potential for liability on the executor’s part if he/she attempts to continue to operate the business.
We recommend that all individuals get an estate plan in place. However, as you can see, there is more planning to be considered when that individual is a business owner. Feel free to contact Jesson & Rains if you have questions about your business or estate plan.
A buy/sell agreement governs how, when, and why partners/owners leave a business, as well as other types of events. A partner’s interest in the business is an asset, and assets are affected at death, divorce, and bankruptcy. As a business owner, you do not want a partner’s death, divorce, or bankruptcy to detrimentally impact the business, right? All of these contingencies can be planned for in advance. We typically encourage our clients to incorporate these provisions in their partnership or operating agreement right from the very beginning, but the buy/sell agreement can be a stand-alone contract.
There are a lot of decisions to be made when going into business with others—naming your business, marketing, capital and profit sharing arrangements, etc. Unfortunately, partners do not always think about the end game, which is exiting the business. Maybe there is a disagreement between the owners as to the future of the company. One partner may want to sell while another doesn’t. If one owner wants to sell just their interest and retire, do the other owners have any say to whom the owner sells to? Should the other owners get the option of purchasing the interest first? If a partner passes away, a family member could inherit their interest, leaving an unsophisticated person running the business with you. Even worse is divorce—during the equitable distribution of a couple’s finances, an ex-spouse could become part owner of a business or force the sale of the spouse’s interest.
Another important concept that many people overlook is how they are going to be able to afford buying another partner out. Oftentimes, having that much cash on hand is impossible. An installment payment plan can be provided for in the buy/sell or operating agreement. To protect against death, life insurance policies are a great way to fund the buyout of a partner who has passed away. The company or the other owners buy policies for each other (but not themselves), and upon the death of a member, the company or owners receive the life insurance benefit. That money can be paid to the family of the deceased as payment for his or her interest in the business.
Finally, buy/sell or operating agreements can stipulate the type of valuation that should be used if and when an ownership interest is sold. There are three main types of business valuation methods: Asset Approach, Market Approach, and Income Approach. Even if business owners agree on who should purchase the interest, if they haven’t previously agreed upon the valuation method, the owners could come up with different valuations and be forced to file a lawsuit and have the court decide.
In the event that business owners have not planned for these almost-certain future events, depending on the terms of the operating agreement, a court can force the dissolution of a business. Many business owners avoid hiring attorneys because of the cost. However, it is important that business owners consider the comparatively small cost of hiring an attorney to assist them with these matters now, as the future cost could be much, much higher, and their business could suffer or be forced to close as a result.
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