One of the advantages to owning a business is that unlike people, the business can live forever.
However, if you own a closely held business it’s vital that you make plans for what would happen to the business if you were to die before you were ready to retire.
Passing on a business to your children requires a combination of careful estate planning and solid business planning.
If you do not have an adequate plan in place, the business may fail or be sold off to the highest bidder.
Estate Tax Issues
One of obstacles to giving your business to your children to run is estate taxes. In Maryland, estate taxes are assessed in cases where the estate is valued at more than $1.5 million. It doesn’t take much for a successfully operating business to be valued high enough to trigger estate taxes.
Maryland also has an inheritance tax that is based on how closely related the heirs receiving assets are to the deceased. The closer the relationship between the heir and the deceased, the lower the tax rate is. Children and spouses are exempt from the inheritance tax, but businesses are not, unless all of the shareholders are exempt.
If there is not enough cash to pay estate taxes, the estate will have to sell off assets to pay the taxes.
In many cases estate taxes make it impossible for a business to pass into the hands of the next generation because it has to be sold off to pay the taxes. But, with careful planning you can make sure your family can continue to operate your business after your death.
Probate is Expensive and Time Consuming
The first step you want to take is to avoid the probate process. Probate can be expensive and take months, or in some cases, years, to wrap up. Your business cannot afford the uncertainty of probate. You need a will and trust setup by an expert estate planner with experience in dealing with business succession.
In addition to the will and trust you will need to have a written business succession plan and secure a way to finance the change of ownership in the business as well as pay the estate taxes that may be incurred.
Just having a will is not usually enough to save your heirs from having to go through probate.
Use Life Insurance to Fund Buy-Sell Agreements
When estate planning and business succession planning has not been done properly there is often a void left when the business owner dies. You likely are the majority shareholder in your business.
What happens to your shares on your death?
You could pass them onto your spouse and try and shelter them from estate taxes in that way, but do you plan on having your spouse run the company?
Also, you can create a bigger estate tax problem down the line for your children if you simply pass all your shares onto your spouse.
If you want your child or children to operate and inherit the business one powerful option is to create a buy-sell agreement that is funded with life insurance. This is different from a regular sale of a business.
The agreement is a written contract where your child agrees to buy your shares upon your death. Then you take out a life insurance policy that names the child as the beneficiary. Under the agreement the child uses the life insurance proceeds to buy the shares from the estate. Then the estate has the cash to pay any inheritance taxes. Of course, this may depend on the size of your business and how your business is set up.
Outline Process for Business Valuation
Another difficulty in business succession planning is deciding how much the business is worth. Business valuation can sometimes be highly subjective.
If there is no plan on how to value the business, upon the death of the owner there can be arguments over how much the shares are worth.
This can lead to schisms in the family or create conflict between the family and other shareholders.
If there is doubt as to the value of the business, it opens up the process to intervention from the courts or can create a prolonged battle with the tax authorities about the real value of the business.
The best way to avoid all of these issues is to create a corporate document that describes how the business should be valued. This document isn’t a declaration of the value of the business, but simply a description of the process used in determining the value.
It could name a specific business evaluation expert who is familiar with the industry and your business to do the evaluation. While this will not guarantee there will not be problems with a business valuation after your death, it does take away much of the uncertainty.
Formal and Informal Succession Planning
There must be a formal, written business succession plan.
If you want to have your child or children run the business after your death they need to know about that and the other key people in the business need to know that. Few things create more strife than a child suddenly coming into take control of a business when they do not have the trust of the key employees at the business.
A succession plan is more than just a simple statement that your child will be in charge after you die. A true succession plan lays out the process for the child to take over.
In addition to a formal succession plan you should have an informal plan where you gradually give your heir more responsibility and control over certain aspects of the business. This is important in helping your key employees learn to trust in their future leadership. It also makes sure your business will be in capable and experienced hands after you are gone.
You have worked hard building your business. Take the time to make sure it continues to grow and prosper long after you are no longer there.