Planning for the Incapacity or Death of a Business Owner

As a business owner, you are used to making plans. You have had to make plans since day one – plans to get your business off the ground, plans to increase inventory, plans to take on employees. . . plans, plans, plans. One plan that some business owners don’t think about until it’s too late is what happens to their business at the death of one of the owners.

Not planning is, in fact, a plan. If no documents are in place to transfer ownership at death, the deceased owner’s probate estate is the recipient of the business interests and the business is tied up in probate court. How can you avoid this happening to your business?

First, check your corporate governance documents. Depending on the type of entity you own, this could be your operating agreement, shareholder agreement, bylaws, or a buy-sell agreement. These documents could outline any restrictions on the transfer of ownership interests. Some of the more common transfer restrictions are to other members or shareholders, revocable trusts, or family members.

Typically, two of the simpler ways to transfer ownership interest in an entity is to assign the interest during the owner’s life to a revocable trust or, alternatively, assign the interest at the death of the owner to the owner’s trust. The terms of the trust can then control where the ownership goes, how it gets to the desired beneficiaries, and who is in charge. Make sure to update operating agreements or bylaws to reflect those changes any time an assignment of ownership occurs. Assignments of ownership interests at death can also be made to other individuals provided the terms of the entity’s operating agreement or bylaws allow for this transfer.

Businesses owned by multiple parties may choose to set up agreements that allow the remaining owners, or the entity itself, the option to buy out an owner’s interest upon death, incapacity, or any other circumstance. The ability to purchase the interests is known as a right of first refusal. Rights of first refusal in buy-sell agreements or other corporate documents typically set forth timelines for exercising the right and the mechanisms for establishing a price to buy the interests. All owners of the entity sign off on these types of agreements when they are put in place.

Many entities that have right of first refusal agreements choose to plan ahead by purchasing insurance on the life of each of the owners, so cash will be available on death to purchase the deceased member’s outstanding shares.  Another way for members or shareholders to purchase interests when cash isn’t available is through a promissory note.

While every business is different, each one needs some sort of plan to prepare for an owner who can no longer participate in the day-to-day operations whether that be because of incapacity, death, or even just a desire to no longer be actively involved. Talk to your attorney and discuss the options available to you and your business.

Published in the December 2023 St. Louis Small Business Monthly.

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