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Seven Common Business Planning Mistakes

Seven Common Business Planning Mistakes

Over the years, I have seen business owners make many of the same planning mistakes in their business documents.   This blog focuses on some of the most common mistakes I have seen.  Here are the top seven:

  1. Not having a good professional advisory team to help your business.

Among other professionals, you need a good business attorney, a CPA, an insurance specialist, a commercial real estate agent, and a commercial banker.  Your business needs a team of these advisors to help your business grow and stay out of trouble.  Without these key professionals to advise you in your business, you will likely make mistakes along the way.  Hence, I strongly recommend a good professional advisory team for your business.

  1. Not setting up an LLC or a corporation for your business.

If you are operating a business in Arizona, you will most likely need to form an LLC or a corporation for your business.  Although in certain situations there are other factors to consider, there are five major factors that you should think about with your advisors in making this decision:

  • Limiting Your Personal Liability.
  • Tax Considerations.
  • Who Can Own an Interest in the Company.
  • Flexibility with Distributions.
  • Set-Up Costs, Ongoing Maintenance, and Annual Filing Fees.

Because of its tremendous flexibility, my experience has been that LLC’s are generally the best choice for most clients.

  1. Failing to have a written agreement between business partners.

Business partners often join forces to start a business.  But oftentimes the same business partners fail to document the terms of their business arrangement.  Having a written agreement with your business partners can help to avoid confusion and potential litigation down the road.  It can also spell out what each “partner” is supposed to contribute to the business, what their percentage in the business is, how profits will be distributed each year, and how sales proceeds would be distributed if the business is ever sold.  For LLC’s, these types of details are generally handled in an operating agreement.  The operating agreement can also address tax issues, management issues, and buy-sell issues.  For these reasons, for my LLC clients, I always recommend setting up an operating agreement to clearly define these important details.

  1. Failing to keep your business documents up to date.

Whether you are setting up your own business for the first time or have been in business for many years, it is important to understand the different documents that are necessary for your business entity to stay in good standing and how to keep those documents up to date. Business owners are often so busy with the day-to-day operations of their business that they forget to address these important details, but there can be significant risks for you and your business if these documents are not kept up to date.  In addition, so often business owners fail to update the valuation of their business as part of their buy-sell agreement.  This can also create major issues in the event of a sudden death of one of the business partners.

The key documents for an LLC’s are the articles of organization, the operating agreement, the member’s agreement (if a more detailed buy-sell language is needed), the IRS SS-4 (to obtain a tax ID number), and other minutes or agreements among the members (as needed).

These documents are extremely important during the following times:

  1. At Start-Up. Typically, the bank and others will want a copy of the Articles of Organization and the LLC’s EIN number.
  2. When Adding a Business Partner. Any potential business partner will want to see a copy of these formation documents in order to see what they say about the ownership, operation, and management of the LLC. These documents may also need to be amended when a new member is added.
  3. When Selling Your Business. When a third party is purchasing your business, they will want to see all of these documents as part of their due diligence for the purchase. If needed, these documents are often updated or amended accordingly prior to disclosing them to a potential buyer.
  4. When a Member Wants to Sell an Interest to a Third Party. These documents often restrict each member’s right to sell their membership interest in the LLC, and they will also have procedures for how a member of the LLC can sell his or her membership interest to a third party.
  5. When There is a Dispute Between the Members of the LLC. Usually, the Operating Agreement sets forth how disputes are resolved. It also includes language about how decisions are made and who is in charge of making them.
  6. When There is a Lawsuit Against the LLC. When a third party has filed a lawsuit or is threatening to do so, they will usually ask for copies of these documents to make sure that the LLC has been set up properly. If it has been set up properly, then there will be liability protection for the individual members of the LLC for LLC obligations. If it has not set up properly, then the individual members may be at risk under a theory similar to “piercing the corporate veil” for corporations.
  7. When a Member Dies. The Operating Agreement typically has language to address what happens to a member’s interest when he or she passes away. Typically, there will either be the ability to pass on such membership interest to the deceased member’s family or a right given to the other LLC members to buy such interest from the deceased member’s family.

Thus, it is extremely important that these LLC formation documents be kept up to date in case they are needed in any of these situations.

  1. Failing to have your estate planning documents “talk” to your business documents.

Many of my clients who are setting up trusts also own one or more LLC’s.  As a result, in the process of setting up their trust, they ask if their LLC should be titled in the name of their trust.   First, before discussing my recommended course of action, it is important to understand how LLC interests are handled under Arizona probate law when a LLC interest owner passes away.

Under Arizona law, if you pass away with assets in your estate that are valued at more than $75,000, then your estate will have to go through a probate. This $75,000 threshold applies to businesses and business interests too. Thus, unless you take some additional planning steps, your business or business interest will probably have to go through the normal probate process in Arizona. This can add additional time to the administration of your estate, additional cost to the administration, and the requirement of filing certain paperwork with the Arizona courts to administer your estate after you are gone. However, with proper planning, you can avoid probate for your business or your business interest by using two relatively straight-forward strategies – owning a business interest in a trust (for businesses owned by one owner or by a married couple) by utilizing a buy-sell agreement (for businesses with two or more owners, excluding married couples).

Finally, once you decide how to handle the business transfer issues in your estate planning documents, it is also important to make sure that your estate planning documents are “talking to” your business planning documents. Both your estate planning documents and your business planning documents need to be tied together, so that that it is clear what happens to your business if something happens to you. When clients have separate estate planning attorneys and business attorneys, a disconnect can often occur. By handling both the estate planning documents and the business planning documents for my business owner clients, I eliminate this “disconnect” by making sure that both sets of documents “talk” to each other.

  1. Not having a buy-sell agreement if your business has two or more owners.

Without a buy-sell agreement, there is chaos when one of the business owners passes away.  As a result, for businesses with two or more owners, I always recommend a buy-sell agreement.

A buy-sell agreement is a written agreement that provides a mechanism for the orderly transfer of an owner’s interest to the other co-owners on the occurrence of certain triggering events. Without an exit plan, the owners of an Arizona LLC are essentially stuck with each other indefinitely even if one of the other owners dies, becomes incapacitated, gets arrested, or files for bankruptcy. A buy-sell agreement defines what happens when these triggering events occur, sets forth the buy-out price, and states whether such buy-out is mandatory or optional for each type of event.  Although there can be several triggering events typically built into a buy-sell agreement, including disability, termination of employment, divorce, felony conviction, loss of license, and bankruptcy, this  blog focuses on death as a triggering event in addressing the transfer of a business.

After a business owner passes away, the buy-sell agreement also sets forth the price for the buy-out. Most buy-sell agreements use the appraisal method for determining the buy-out value, because it is extremely difficult for co-owners to agree upon a value for the business or on a formula to determine the value at the time of the agreement. Plus, over time, the value can go up or down. In addition to the buy-out price, the buy-sell agreement also sets forth the terms of the buy-out, so that the timing of the buy-out payments is “locked in” when the death occurs.

You may have been thinking about these things over the last few years, but you are wondering how to start the process. The first step is to get your key advisors involved in the discussion, including your attorney, your accountant, and your financial planner. If you choose to do a buy-sell agreement, you may also need to get a good life insurance person involved. Certainly, you will need to schedule some time to work through these issues on your own, but your advisors can often help you work through this process more efficiently.

  1. For sole owners, failing to plan how your business will be passed on.

For many of my clients who own businesses, their business is the largest asset in their estate. As a result, it is critical that this asset is properly handled after their death.

If the business is owned by a single owner or by a married couple, then buy-sell agreements are not appropriate. One way to solve this issue is to have another owner, often a key employee, buy into the business and become a minority owner. Then, there is another owner in the business, and a buy-sell agreement can be used to buy–out the original owner at his/her death.

Other times, when the owner does not want to bring in additional owners or wants to pass the business on to his or her children at death, these provisions need to be addressed in the business owner’s trust or in the formation documents for the business. Although the successor trustee certainly has the authority to run the business after the owner’s death, he or she often does not have the expertise to do so. As a result, the value of the business may go down after the business owner dies.

One idea that is helpful to maintain the post-death value of the business is the concept of a management committee or a board of directors to oversee the operation of the business after the business owner passes. The management committee or board of directors’ concept can also be incorporated into the business formation documents. However, it is always important to coordinate provisions in the trust with the provisions in the business formation documents. If possible, it is also helpful to select someone to take over as the president of the business after the owner passes and to put that person’s name into the trust or business documents (after talking with them, of course!)

Need help? Please call me today – 602.277.7000

John EvenOur firm has helped hundreds of families just like yours handle a wide variety of estate planning, business planning, probate, trust, and elder law issues. When families or business owners are not getting along, we can also handle any disputes and litigation related to their businesses, wills, trusts, guardianships, or conservatorships. Please give me a call, so that I can help you work through these difficult issues with confidence.


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