Pass it on: Estate planning is tougher when a business is involved.
Planning who will receive your assets after you pass away can be a challenging task. But if a growing business is part of your asset mix, estate planning can be even more complicated, financial experts say.
Ensuring that heirs share appropriately in the benefits of an ongoing business is far different from determining how cash, real estate and other hard assets will accrue to a surviving spouse and offspring.
Alton “Biff” Bayard III, an estate planning and tax specialist with the Baker Donelson law firm in Baton Rouge, advises business owners to start planning at an early stage in a company’s growth and keep in mind a key point:
“‘Fair’ does not always mean ‘equal,’ and equal is not always fair,” he says.
Bayard says a business owner’s estate planning often requires asking sensitive questions, such as: Will my child or children have any interest in taking over this business? Do they have any aptitude for managing it? If one child becomes involved and others don’t, what is the fairest way to ensure that they all benefit from the operation? What about the child who is notoriously irresponsible—should he or she receive the same consideration as the others?
In cases where a business owner has a “blended” family, the questions get even trickier: Will my former spouse share equally in the business profits with my current spouse? Should children from my first marriage and my later marriage share equally? What about the grandkids?
Bayard says most parents try to be generous. “They virtually always want to be fair, and many times they’ll start out thinking that in order to be fair, everybody should receive an equal share of the assets,” he says.
But being fair is hardly ever a matter of simply carving a business into equal parts. A spouse or child who participates intensively in building a company, for instance, may feel resentment toward other family members who have little or nothing to do with the business but end up profiting from it.
BREAKING IT DOWN
Bayard says one option for involving multiple family members is to give them seats on the board of directors and identify certain seats as “voting” and others as “non-voting” interests. That way, those persons who devote more of their time to the business get a bigger say in how it operates.
Profits from the business also could be apportioned based on the level of family members’ involvement by granting heirs a varying number of shares in the company.
Bayard says another approach to treating heirs fairly is to distribute different types of assets to different people. “If there are enough non-business assets in the estate, you could maybe leave those assets to the individuals who are not involved in the business,” he says.
Often, however, most of a business owner’s net worth is invested in the company, with any remaining assets tied up in retirement funds and a few real estate holdings.
Jennifer Treadway, an estate planning specialist in the Fenet Treadway Gaudin law firm, says for most entrepreneurs, their business is their largest asset, and therefore estate planning is intertwined with planning how their company will continue to operate after they die.
Sometimes that transition is smooth, if relatives of the owner have been deeply involved in the company for some time and are fully capable of taking charge.
But in cases where relatives have had little involvement, Treadway says the owner should take care to fund a business succession plan.
“You need a plan that says who steps up and takes control,” she says.
Treadway advises business owners to establish a financial cushion for the transition period after their death. The cushion might take the form of a life insurance policy on the founder purchased by the company and naming the company as the beneficiary. Or it might be a cash account into which the business deposits a monthly amount toward building a transition fund.
“If the company’s customers have dealt only with the founder over the years, his or her death can be a huge loss” and it can take considerable time to right the ship, Treadway notes. “The company will need to cover the income loss brought on by that person’s death, so you want to have cash available to help the business through this period.”
Insurance can also be used to help “expand” an estate for the benefit of heirs not involved in the owner’s business, says Bayard, at Baker Donelson.
“You could set up an insurance trust and name as beneficiaries the family members who won’t become owners of the business upon your death,” he says.
A FRANK DISCUSSION
Bayard says a factor that can undermine estate-planning efforts is an owner’s tendency to make incorrect assumptions about his or her family.
“A lot of parents tend to assume that continuing to keep the business in the family and operate it for future generations is just as important to their children as it is to them,” he says. “But that’s not always the case.”
Bayard recommends that parents have frank discussions with their children “at the appropriate time” to get an idea of how the kids actually feel about the business.
Because every family is different, parents are the ones who should determine at what age their kids are ready to discuss the subject, he says.
Some owners will simply have to face the fact that none of their relatives want to be involved in their business, in which case the best option may be a sale.
“Sometimes the best solution is just to sell to an outsider,” he says.
The “outsider” may well be a non-family member who has been a key employee or manager of the business for years and has become integral to its ongoing success.
“You may want to create options that would give those managers the ability to buy the business from the estate,” Bayard says.
While no estate plan can protect a business owner’s wishes in all possible scenarios, good planning can help families avoid problems during a difficult and emotional period.
Bayard says an owner’s best bet is to get a plan in place that seems to be the right arrangement at that particular time, and then tweak it as time passes and family circumstances change.
Establishing a relationship with trusted estate and tax-planning professionals early in the life of a business, Bayard says, can prove to be a crucial step that pays dividends down the road.