You spend a significant part of your life building your business, and it becomes a major part of your legacy. But when you die, everything you have built could fall apart if you have not taken the time to create a business succession plan. Without a plan in place, your business’s fate may be decided by a court instead of according to your wishes. You can take actions now to position your business for continued success—even when you are no longer around to run it. Depending on the type of business entity you have formed, a business succession plan can be addressed in your last will and testament, the business’s operating agreement, or in a buy-sell agreement. Consider consulting with an attorney who can explain the options for business succession planning and help you take the necessary next steps.
Business Succession Planning Considerations
Before you create a succession plan for your business, keep in mind the following key steps:
- Determine the type of business entity. Is your business a sole proprietorship, partnership, limited liability company, or corporation? The type of business entity affects more than just taxes and day-to-day operations. It can also affect the succession planning options available to you. If you own your business as a sole proprietor, for instance, no one else has an ownership interest, so you are free to pass the business on to your chosen successor (or successors). But if co-owners are involved, your share of the ownership could be distributed to them per the terms of an operating agreement or other legal document.
- Determine who gets the business. Some owners want to pass their business on to their family, and it may make sense to do so in a will upon the owner’s death. Other owners may want to have the business sold after they die so that the proceeds can be distributed to their beneficiaries. Business owners can also leave their businesses to nonfamily members, such as employees or charity. Still, some owners may prefer that the business continue to operate while they leave their interest to one or more co-owners. In this case, a buy-sell agreement can ensure that the decedent’s beneficiaries do not unintentionally become owners.
- Plan for management and ownership. Your business succession plan must do more than simply name who receives your business. A succession plan should address issues such as training and supporting successors; delegating duties to successors; naming outside directors, advisors, and professionals; designating who will own the business versus who will manage the business; and retaining key employees. Thinking ahead about such issues will improve the odds that ownership and management changes won’t cause the business to fail.
- Get creative. Wills, operating agreements, and buy-sell agreements are common legal documents used to specify what happens to your business when you pass away. There are some other solutions that might work well, however, depending upon your particular situation. One solution is gifting the business to a successor while you are still alive. Another is to create a living trust and transfer the business into the trust during your lifetime, with the person you want to succeed you named as the successor trustee who will step into your shoes at the time of your death. Other succession strategies you can consider involve creating a grantor retained annuity trust, a grantor retained unitrust, or an irrevocable life insurance trust, or setting up a family limited partnership or a family limited liability company.
The Risks of Not Having a Plan
Not having a business succession plan could lead to headaches and disputes for your heirs and damage the company you spent years building. The following are some risks of not having a plan:
- Business assets and ownership will go through probate. Business assets, including ownership interests, generally must go through the probate process upon an owner’s death. This may not be a problem if your will describes in detail the distribution of business assets to beneficiaries. But if your will is silent on this subject, the assets will be divided among your beneficiaries when your estate is settled. At that point, your business is unlikely to end up in the hands of the successor you would have chosen.
- Your heirs will owe taxes and expenses. Probate expenses are paid out of the estate. Through careful planning, you may be able to transfer business assets outside of probate, leaving more for your heirs. Strategies used to avoid probate may also minimize estate and inheritance taxes that are levied on the decedent’s assets. The threshold for the federal estate tax is quite high, but seventeen states also have an estate tax, an inheritance tax, or both.
- The business fails. Succession planning does not guarantee the continued success of the business after you die. Although the eventual outcome is outside of a deceased business owner’s control, you can take steps to position the business for success. Small details matter. Is your chosen successor likely to work well with existing associates? Are the best interests of your business and the best interests of your family compatible? Should you transfer the business during your lifetime? How will your departure from the business affect suppliers, creditors, customers, and employees? When did you last review your estate and succession plans, and have there been significant changes to the business since then?
Understanding business succession and creating a comprehensive plan can allow your company to thrive in your absence. Don’t leave anything to chance. Talk with a professional — experienced in business law, tax, and estate planning — about how to protect the legacy of your business.