What happens to your business when you die?
By Elliott Stapleton
When you start a business, you are likely focused on the product or service, suppliers, contractors, employees, and marketing. What you probably are not focused on is what happens if you die.
While it is understandable to not consider the consequences of death to your business, it is reasonable to prepare for it. Why? Because it is expensive to miss and easy to fix.
Expensive to Miss
The death of a business-owner can be problematic. There may not be a person to approve payroll, pay rent (or mortgage), sign checks, or even unlock the door. If your company cannot pay its employees, creditors, or fulfill its obligations, then the value you have worked hard to build will evaporate.
Death is not effectively addressed in over 50% of the business documents (such as Operating Agreements, Corporate Regulations, Close Corporation Agreements, and Bylaws) I’ve reviewed. I say "effectively" because if death is mentioned, it is mentioned only as a casual aside; in some cases, death is not addressed at all.
Every owner of a business will die. When the owner dies, how will the owner's interest be transferred? Some operating documents say the interest will transfer, but not how. If we do not say "how" a beneficiary will receive the ownership interest at death, by default, the assets will go through Probate court. If we say nothing about death in the ownership agreement, the interest will also go through Probate.
You do not want your ownership interest to go through Probate. Why? To do anything with a business interest after death, passing through Probate, you must start a court proceeding. This process includes meeting with an attorney, reviewing documents, mailing them to family members to secure waivers or notice, and waiting for a 90-day Will contest period to expire. All of this is necessary before someone can sign on behalf of the ownership interest.
The total time for Probate Administration ranges from six to twelve months. In Probate, an inventory must be filed, meaning the ownership interest must be appraised and it also goes on the public record (you can request the record be sealed, but this is not always possible).
For the deceased owner's family, the cost to administer the Probate Estate ranges from 3%-5% of the assets. For example, if the total value of the business interest is $1,000,000, the potential legal cost could be around $40,000.
Third parties may contest the Will and the Assets that are in Probate. Depending on the complexity, the contest could take many months or even years to resolve—all the while, the ownership interest would be in limbo.
Finally, if the operating documents do not address Buy/Sell options at death (partners/shareholders agreeing to buy a deceased owner's interest), the surviving owners might have new partners/shareholders. If the new partners are the deceased partner’s spouse or children, are they capable or willing to run the business? If not, the business may be forced to hire an employee to do the work.
Easy to Fix
How can I preserve my business's value at death?
By creating a step-by-step succession plan that will lay out all the necessary information and access to keep the business running. This includes the appointment of a temporary manager to ensure business’ essential expenses are paid after death.
How can I keep the business out of Probate?
You can create a one-page document, signed by all owners of a company, identifying the “transfer-on-death” beneficiaries. This document should work in tandem with the Operating Agreement, which establishes the rights and duties of all owners of the company.
While not required, the owners may name a Trust to receive the ownership interest at death. Listing a Trust will ensure a clear line of succession for beneficiaries to receive the ownership interest without the Probate court's involvement. More on this topic below.
A Buy/Sell Agreement will establish terms related to the buyout of a deceased (or disabled) member's interest. This might be created in concert with setting up reciprocal life insurance policies on each partner to pay a deceased owner's family.
Gain more flexibility with a Trust
Perhaps you want the business to go to multiple people with different terms of distribution. Or you intend to give one beneficiary a greater share than other beneficiaries. Or perhaps you want the company's value at the time of your death to determine the percentages of distribution. Or you prefer to delay ownership in the company to young beneficiaries who are not yet ready to receive outright ownership (or value) of the company.
For business owners interested in avoiding Probate with maximum flexibility on distribution should use a Trust. To solve the challenges listed above (and address other issues outside the scope of this article, such as Estate Tax planning), it is best to direct your ownership interest to a Trust.
A Trust can have nuanced instructions for distribution and provide creditor protection for the beneficiaries of the Trust. Furthermore, it allows you to designate an immediate person, your Trustee, to make decisions on behalf of the business. This method does not require any court supervision and it avoids the Probate process while still ensuring assets get to the right person at the right time.
The fate of your business and its value is in your control.
Your death could result in a smooth transition which preserves the value you have built. You could avoid Probate, create a Trust to carefully manage distributions, and prepare a Buy/Sell Agreement to protect your partners.
Alternatively, your death could result in unnecessary costs for your family and leave partners and coworkers scrambling to figure out what to do without you; devastating your company’s value.
Your path is your choice.
Elliott Stapleton is an attorney and partner of Cornetet, Meyer, Rush & Stapleton, Co., L.P.A, a law firm located in Cincinnati, Ohio. Elliott advises clients on Estate Planning, Probate, Trust Administration, and other forms of asset protection.