The following is a true story of two businesses. Two professionals owned their respective businesses and successfully built them into thriving practices. Each professional decided to bring a partner on board to share the burden and benefit of ownership. And, unfortunately, each professional died while still engaged while still practicing their respective trades, leaving their business partners and family members to pick up the pieces.
Professional A had entered into a buy-sell agreement with his partner. The agreement was fully funded by having each partner buy a life insurance policy on the life of the other. When A passed away, his partner submitted a claim to his life insurance policy. Three months after A’s death, his partner received the proceeds from the insurance policy, and used them to buy out A’s widow. The partner had complete ownership of the business and A’s widow received the full value of her husband’s hard work.
Professional B hemmed and hawed about preparing a buy-sell agreement with his partner. A draft agreement was prepared, but never signed. No funding mechanism was ever decided upon or implemented. When B died, his partner decided that it was his hard work that created the value in the practice, not B’s. B’s widow tried to buy the partner out, but the partner refused. Lawsuits commenced with neither B’s widow nor the partner receiving the proper value for their hard work. Three year’s after B’s death, the lawsuit is still not resolved.
The difference between the end results for A and B’s families illustrates how a properly executed and enacted business succession plan can be the difference between finding a way to move on and being mired in a conflict that outlives our relatives. It is not enough to just have a succession plan for your business, but the plan needs to consider five important issues, namely:
- Who will own the business-Business owners must decide if their business will continue by transferring ownership within the company or to parties outside the company. For family businesses, having children and other relatives who are divided between active and inactive participants in the business can complicate this issue.
- Who will manage the business-Many business owners focus solely on the ownership question without considering who will actually manage the business once they are gone. Failure to name a successor and prepare that successor for the tasks he or she may face is a common reason for a business succession plan to fail.
- How will the buyout of the departing owner be paid for-Regardless of whether a funding mechanism exists, the departing owner or his or her estate will be taxed for the value of their business interest. By preparing in advance for how a buyout will be paid for is crucial to not only maximize the value the departing owner or his or her estate receives, but also to prevent taxes from being paid from non-business related assets.
- For family businesses, what about non-owner family members? In some instances, not every heir of a business owner will inherit a piece of the business he or she built. This may create jealousy or resentment if the non-owner heirs are not equalized in some form. Dividing non business assets more favorably to non owner heirs, purchasing life insurance for the benefit of non owner heirs and providing a non ownership income stream from the business are some examples of how to equalize the non owner heirs.
- Special issues for professional businesses (professional corporations and professional LLCs)-Under the New York Business Corporation Law, a professional business cannot be owned by individuals not engaged in the specific profession that the business is engaged in (medicine, law, etc.). The family of a deceased professional will be able to receive a redemption of the deceased professional’s business interests. However, without a defined valuation clause or buyout provisions, this may provide the family with only a fraction of the true value of their family member’s interest.
The failure of a business owner to plan for their eventual exit from their business, whether for retirement, death or disability, can wreak havoc for their business and family alike. Planning ahead, as with all forms of planning, provides a business owner with their best chance of allowing both to thrive once they are gone.
Please contact firstname.lastname@example.org for more information about business succession planning.