Can Your Family Business Survive Losing You?
NOVEMBER 23, 2016 BY DBORGER5115
Do you own a small business? Are you a partner in a small business? Have you ever stopped to consider what would happen to your business or partnership interest if you were to die or become incapacitated? What if you divorced your spouse? If you’re like most small business owners, the answer to the questions is a resounding “No.”
Owning and operating a small business can be a richly rewarding experience, both personally and financially. It provides entrepreneurial types with a wonderful array of opportunity, free from the shackles of corporate drudgery – a chance to follow our passion, control our own destiny, choose our own co-workers, define and assume our own risks and to create our own work / life balance. This opportunity comes with a price, however; long hours, increased personal and professional liability, and the juggernaut of bureaucratic compliance are our burden. Small business owners are busy planning for success, and why not? Stay focused, set goals, work hard to achieve those goals and you will succeed. It is the American Dream. What happens to that dream, however, when things don’t go as planned?
The truth is, most small businesses and partnerships are not sufficiently prepared to survive the occurrence of an unexpected life event. The small business owner’s reluctance, however, to plan for life’s inevitabilities, called “trigger events” – sickness, divorce, incapacity, death – can prove to the modern day entrepreneur’s heroic flaw, the one omission that undermines and unravels years of hard work and wealth creation.
Without proper planning, the death or incapacity of a sole proprietor or partner can have disastrous consequences for surviving family and business associates. The typical response to a trigger event is for each affected party to “lawyer up” resulting in expensive litigation to resolve such questions as: How much is the business interest worth? Who will we hire to appraise it? What about surviving family members? Will they run the business now? Will the surviving spouse have a say in how the company is operated?
Divorce can have an equally-disastrous effect on small business. Unanticipated questions about the division of a partnership interest during divorce can threaten the management of the business itself. Does the non-partner spouse acquire an interest in the business at divorce? Does that spouse have a say in the management of the company? Can the company purchase the community property interest of the non-partner spouse? And at what price? How is that interest valued? Can the surviving spouse sell their interest to an outside third-party?
From the examples above, it is obvious that a lack of proper planning can destroy a small business unprepared to deal with issues that families deal with every day. It doesn’t have to be this way. One of the best ways to avoid this anguish is through the drafting and implementation of buy-sell agreement.
Here are some interesting facts:
- By 2017, it is estimated that 40.3 percent of family business owners expect to retire, creating a significant transition of ownership in the US. Less than half of those expecting to retire in five years have selected a successor.
- Nearly a third of family business owners (31.4 percent) have no estate plan beyond a will. Only 53.5 percent of these owners reported having a “good understanding” of estate taxes that could be due.
- Even though nearly 70% of family businesses would like to pass their business on to the next generation, only 30% will actually be successful at transitioning to the next generation.
A buy-sell agreement, also known as a buyout agreement, is an agreement between co-owners of a business or between a sole proprietor and his or her chosen successors that anticipates these trigger events and provides rules for the valuation and disposition of interests affected by those events.
The buy-sell agreement will define those significant life events and will define how a business will responds to those events. The agreement will govern how interests are valued, who can purchase those interests and will often provide a method of financing the purchase of those interest. A buy-sell agreement, when included as part of a comprehensive estate plan, can be an important tool in providing for surviving family members, who might not be able or interested in continuing in the small business.
A buy-sell agreement can also be an important part of premarital planning.
1. Mass Mutual American Family Business Survey, 2007. Retrieved November 2012: (http://www.massmutual.com/mmfg/pdf/afbs.pdf.)
2. Mass Mutual American Family Business Survey, 2007. Retrieved November 2012: (http://www.massmutual.com/mmfg/pdf/afbs.pdf.)
3. Peak Family Business Survey. 2011. Retrieved June 2014: (http://www.amserv.com/index.cfm/page/Family-Business-Statistics/pid/10715.html)