Let me paint the picture. You are in your 60’s or early 70’s after having working the last 20-30 years building up a successful family business and you are trying to figure out a way to slow down and enjoy some of the fruits of your labor. Some of your family members work in the business, and others do not want to have anything to do with it. In addition, some of your children have the ability to run the business, but you are not quite ready to turn it over to them yet. As you sip on your Corona on the beach in San Diego, you wonder: How do I this? Where do I start?
For most business owners, their family business is a huge part of the value of their estate. Yet, so many business owners fail to properly plan for the transfer of their business as part of their estate plan. However, this type of planning is crucial for the success of your business. If you have not already drafted your business succession plan as part of your overall estate plan, then I strongly recommend that you start the process when you get back from the beach in August. With proper planning, you can probably get the documents drafted and in place by the end of 2017 if you start when you get back. But don’t delay, as these business succession plans have a way of working their way back onto the “back burner” when things start to pick up again in late August or early September.
Although there are other options, the three most common options are discussed below.
One way to transfer the business to your children is to sell them your interest, outright, during your life. If you sell it to them, then you will need to sell for fair market value, or else the transfer may be considered a part sale – part gift, which could trigger gift taxes with the IRS. The terms of the sale are also important. For an outright sale, there are essentially two options. First, there can be a cash sale where the children pay the full purchase price at the time of closing, typically with the assistance of bank financing. Second, the buyer pays off a seller carry-back note over time. For either option, it is important that the cash flow of the business be able to support the bank note payment or the seller-carryback note payment, so that the buyer will be able to make these payments; otherwise, the whole transaction could implode in a few years when the buyer cannot make the payments. Although there are numerous ways to structure the buy-out, I have often seen the carry-back note include a balloon payment, so that the seller can reduce the risk of payment of the balance of the note at some point. In addition, in some cases, I have also seen a buy-out structured over time whereby the children buy a small interest in the business over time and then make a final purchase of the balance of the business at some point in the future. This last method allows the current owner to maintain control of the business for now, while he or she retains a majority interest in the company.
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 or corporation are essentially stuck with each other (or their spouses) indefinitely even if one of the other owners dies, becomes incapacitated, gets arrested, or files 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 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.
Next, because a buy-sell agreement is an agreement between owners of the business, it is important for the current business owner (typically one of the parents in the family) to understand that their children will need to be owners of the business now in order to create this document. If there is only one owner of the business or the owner of the business is a married couple, a buy-sell agreement will not be the answer. If the owner wants to pursue a buy-sell agreement, then I usually recommend gifting or bonusing enough funds to the children (or certain children) to allow them to purchase a small interest in the business (even if it is only a 1% interest). Once there are two or more owners of the business, then it is possible to enter into a buy-sell agreement.
Finally, if you are going to go to the expense of setting up a buy-sell agreement, I always recommend purchasing buy-sell life insurance to fund the buy-out in the event of a death. If one or more of the owners is not able to obtain life insurance, this needs to be discussed thoroughly prior to finalizing the buy-sell agreement, so that there is not an unfunded obligation created for the company or for one of the owners of the company.
If the owner is not ready to bring on additional owners or does not want to pass the business on to his or her children until his or her death, these transfer provisions need to be addressed in the business owner’s living trust and may also need to be addressed 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 do not have the expertise to do so. As a result, I often see the value of the business, typically the largest part of the business owner’s estate, decline in value after the business owner dies.
One idea that is often helpful to maintain the post-death value of the business is the concept of a management committee or board of directors to oversee the operation of the business after the business owner passes. The management committee or board of directors’ concept can be incorporated into the business owner’s living trust, and it can also be incorporated into the business’ formation documents, as long as all of these documents are coordinated with each other. If possible, it is also helpful to select someone to take over as the President or Manager of the business after the owner passes and to put that person’s name in the will or trust or business document (after talking with them, of course!)
Our 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.