Most small business owners barely have time to stop to catch their breath, much less think about their estate plans. However, for a small business owner estate planning can be as important as budgeting, forecasting or any other planning.
Why is estate planning important to small business owners? More than likely, if you own a business a large part of your personal wealth is tied to that business. Without a plan you lose the ability to manage the transition of your business, and your wealth. Estate planning enables you to be in control of what happens to your business interest upon your death or incapacity, rather than leaving it to state law, family members, your partners, or even creditors.
Review Your Will or Trust to Ensure it Addresses Your Business Ownership Interests
If you already have a will or trust in place, review it to make sure it addresses your intentions for your business interests upon your death or incapacity. This may include a specific provision in your will that passes your business interest to your spouse, or other family members, or a specific acknowledgement of your business ownership interests and a statement your intent that your family honor the terms of an existing operating agreement.
If your existing estate plan is silent as to your specific business interests, more than likely that means that your business ownership interests will pass with the remainder of your estate. While you may wish that your family receive your business ownership interests, it is important to specifically address how your heirs or family members may, or may not, be involved with your business and its operations.
If You Do Not Already Have an Estate Plan in Place, Make it a Goal for Your Business
Again, estate planning allows you to be in control of the distribution of your business interests, rather than leaving it to state law, or in the hands of your family members, business partners, or other third parties. Estate planning for business owners includes the traditional estate planning tools, such as wills and trusts, as well as internal business planning documents. At a minimum, your estate plan should include a Last Will and Testament and/or a Revocable Living Trust, as well as Power of Attorney documents for financial and health care decisions, and an operating agreement for the business.
Discuss your business transition goals with an estate planning attorney to ensure that your estate plan reflects intent for your business and your family.
Review or Create an Operating Agreement
If you own your business with another partner, or partners, an operating agreement is an essential estate planning document for you, as an owner, and the business as a whole. (For discussion purposes the term “operating agreement” is used here to generally discuss internal documents for the operation of various business types, but a different term may be used for a different type of entity, such as shareholder agreement for a corporation.) An operating agreement is a contract between the owners, and the company that guides the operation and transfer of a business. In addition to estate planning issues, such as death or incapacity, the operating agreement can also address how to determine the value of the business upon a sale, how individual owners may join or withdrawal from the business, or how to handle a dispute between owners.
While most individuals would prefer not to discuss the issue, planning for an unexpected death or incapacity of an owner or manager, an operating agreement will enable the business to carry on, even if an owner may no longer be able to manage the business. It is important that the members or owners of the business have a discussion as to the important points of the operating agreement. This ensures everyone is on the same page and has discussed these issues from a planning perspective rather than trying to figure out these issues in the event of a disagreement or other unknown circumstance. When discussing how to plan for an unexpected death or incapacity of an owner or manager with other owners or with your family consider the following:
• Ownership Transition and Buy-out: Do you want the business to buy-out the heirs or family?
• Control & Management: If the business does not buy-out the heirs, does it want those heirs to have an active role in managing the day-to-day operations of the business? Or any amount of voting power?
• Financing: What resources are available upon death? If the plan is to buy-out the heirs or family members, how will it be financed? Some options may include installment payments, life insurance, or the creation of a separate fund.
• Price: How do you establish a price to buy out? Price can often be calculated as book value, multiple of annual earnings, by appraisal, or otherwise by agreement of all owners.
These are only a few of the discussion points to consider when creating an operating agreement. A business attorney can advise you on options for your particular business and assist you in drafting an operating agreement that meets you needs.
Create a Separate Entity
If you are a solo proprietor, or a general partnership, the beginning of a new year is the perfect time to start thinking about setting up a separate business entity such as a Limited Liability Company (“LLC”) or corporation. LLCs and corporations protect personal liability by placing liability on a separate entity rather the business owners as individuals. Moreover, a entity that is separate from the individual owner(s), survives the death of an owner, which makes it easier for your business interests to be distributed to your family without the need for probate.
The decision about the legal structure of your business will impact your personal liability, ownership rights, and business operations. Making the right decision about the legal and corporate structure of your business is critical to your long-term success, so discuss your options with a business attorney to determine what is right for your specific business.
Communication is Essential to Successful Estate Planning for your Business
The most critical component of successful estate planning for a small business is communication. Talk to your partners, family members, tax and legal advisers to ensure that your intentions can be met and to facilitate a smooth transition for your business. Estate planning for a business owner does not need to be complex or lengthy, but it needs to be discussed and completed. Communication with those involved, along with some basic planning will enable your family, and business to carry on in the event of an unforeseen circumstance.
Don’t wait for the unexpected to happen and then to try figure out what to do next. Take some time to create an estate plan that addresses your business interests and keep the control of your business in your own hands.