Estate Planning Tips for Business Owners

ESTATE PLANNING TIPS FOR BUSINESS OWNERS

Next to their family, business owners normally care most about their business. Although MANY business owners plan to live forever, there is little evidence of success in this endeavor. Accordingly, this article will focus on some alternatives to the “live forever plan.”

1. Overview
   1. In the context of an estate, the ownership interest in the business is an “asset” just like a stock, a bond, or real estate
   2. At the “passing” of the business owner, the ownership interest in the business transfers in one of three ways:
      1. Pursuant to Statute
      2. Pursuant to a Will or a Trust
      3. Pursuant to a Buy/Sell Agreement
2. Intestacy Statute
   1. This is the “default” provision in the event that owner does not have a Will, Trust, or Buy/Sell Agreement.
   2. Basic provisions of the statute are:
      1. If there is a surviving spouse:
         1. If all of the deceased’s children are children of the surviving spouse- the surviving spouse gets everything[1]
         2. If the deceased has children from another relationship then the surviving spouse gets half and the children who are NOT the surviving spouse’s children collectively get half in equal shares[2]
      2. If there is no surviving spouse[3]:
         1. Everything to the children of the deceased in equal shares.
         2. If no children, to the parents of the deceased.
         3. If no parents to the siblings of the deceased
         4. There are additional provisions, but if NO family is found it goes to the state.
      3. Problems with business owners relying on the statute
         1. It may result in family conflict
            1. Spouse may not have sufficient experience to run the business OR to maximize the value of a sale of the business
            2. Disagreements OFTEN arise between surviving spouse and children of another relationship
         2. Children or siblings may not have sufficient experience to run the business OR to maximize the value of a sale of the business
         3. A conservatorship would have to be established for a beneficiary who is a minor or not capable of making business decisions. The Conservator would vote corporate shares.
         4. The operations of the business and its value could be GREATLY compromised by:
            1. Key employees leaving or sabotaging operations to get a better price
            2. Competitors taking advantage of inexperience owners
         5. The business owner’s wishes are not expressed
3. Will or Revocable (Living) Trust[4]
   1. These are generally be considered to be alternate disposition formats
   2. A properly drafted Will or Revocable Trust is a blueprint of how the business owner’s succession plan will be carried out
      1. Estate planning is ultimately about providing “peace of mind” to the owner. Reliance on statute rarely provides that.
      2. There are really two key estate planning alternatives available to the business owner:
         1. Passage of the ownership of the business itself
         2. Pass the value of the business rather than the business itself
   3. By establishing a Will or a Trust, the business owner can select a qualified individual or institution to serve as Executor and/or Successor Trustee[5]
   4. WHO serves as Executor or Successor Trustee MATTERS because:
      1. Unless there is language to the contrary[6], the Executor or the Trustee can actually sell the business on behalf of the Estate[7] or Trust[8]
      2. If the business is structured as a corporation or single owner LLC- the executor[9] or trustee[10] votes the shares/membership units
      3. Accordingly, in essence, the Executor or Trustee controls the business until control is turned over to the beneficiary[11]
   5. Establishing a Will or a Trust allows the business owner to make “appropriate” decisions regarding ownership of assets, INCLUDING the ownership of the business
      1. In the absence of a Will or Trust a business owner cannot select beneficiaries of assets (see above discussion regarding intestacy)
      2. In the absence of a Will or Trust, all assets not going to a surviving spouse go to all beneficiaries of the “class” of beneficiaries in equal shares
         1. Example-if no will and no surviving spouse but there are 3 surviving children- each child gets 1/3 of ALL assets including 1/3 of the business
         2. A business owner may want different asset ownership allocations Example: Child A gets stock portfolio; Child B gets business
      3. Because a Trustee would make decisions regarding the business for an under-aged, inexperienced, or otherwise unqualified beneficiary, a Will which establishes a trust, or a Revocable Trust can avoid bad business decisions as well as squandering of assets.
   6. If a revocable trust is used, the business interest should be transferred to the revocable trust during the owner’s lifetime; this is not necessary for transfer by Will
   7. Problems with Wills and Trusts
      1. No certainty that the business can/will be sold at a reasonable price
      2. May be difficult for the recipient to run/sell the businessF
      3. Family members who hold minority interests could interfere with operations, even if they do not have a right to do so
      4. Bequests of business interest may create family disharmony
         1. Recipients of minority interests in the business could feel slighted
         2. if the business is the primary asset of the estate, the business owner may not feel a disproportionate bequest is “fair” and therefor give equal shares to all beneficiaries which may not be best for operating or sale of the business
         3. Minority interests could essentially be worthless, but used as a “weapon” in the event of a potential sale of the business
      5. A surviving spouse may have a right to some or all of the business
         1. Unlike intestacy[12], if there is a Will or a revocable Trust a surviving spouse has a right to 1/3 of each type of asset which comprises the total estate[13]
         2. Although this does not mean that a surviving spouse has the right to aggregate their statutory entitlement to obtain one type of property, in estates where the primary asset is a business, through exchanges, a surviving spouse could wind up with a majority interest
4. Buy/Sell Agreements
   1. A Buy/Sell Agreement causes a transfer of the “value” of the business rather than the business itself
   2. The key benefits are
      1. They create a “market” or a buyer for the business
      2. They set an expectation as to the value of the business
      3. They can provide liquidity for the estate
      4. They can allow for division of an otherwise non-divisible asset
      5. They can provide for centralized business decision making
      6. If the pricing and terms are appropriate this can result in family harmony
   3. Types of Buy/Sell Agreements
      1. External- Someone outside of the family is the potential buyer
      2. Internal- a family member is the potential buyer
   4. The purchase price and terms of payment are always key concerns
      1. Pricing can be based on a “formula” so that the price automatically changes as time passes. Common formulas include:
         1. Appraised value
         2. Book value (often with adjustments for assets whose value is greater than their depreciated value)
         3. Periodic agreement of the parties (with a “formula” as back up if no agreement is reached)
      2. The terms normally contemplate that if there is life insurance, that it will be used to fund the purchase, and any remaining purchase price is paid in installments
   5. Buy/Sell Agreements can be contained in a Will or a Revocable Trust
      1. Example: beneficiary A has the right to buy the business from the estate at the “fair market value” as determined by an independent appraiser.
      2. The beneficiary, in effect, gets a “discount” for their percentage of the estate since they don’t have to buy that from themselves.
      3. The Will or Trust could provide that if the beneficiary doesn’t want to buy, the business gets sold by the Executor or the Trustee

Benjamin Franklin taught us: “if you fail to plan you are planning to fail.” Although reliance on the intestacy statute and the “live forever plan” may be the most common plan of business owners, these plans have not proven to be successful. We encourage business owners to establish a Will and/or a Revocable Trust so that their business will create a legacy for their intended beneficiaries.

Call the Kreamer Law Firm, P.C. at 515-727-0900 or e-mail us at info@kreamerlaw.com if you need to update or create your estate planning documents, and/or establish a Buy/Sell Agreement.

West Des Moines Lawyer, Des Moines Lawyer, Estate Planning, Business Law Des Moines

[1] Iowa Code §633.211

[2] Iowa Code §633.212

[3] Iowa Code §633.219

[4] A Revocable Trust is recommended IF the value of the total estate is in excess of the “applicable credit amount” as described in IRC §2010 which as of 11/6/2016 is $5,490,000 for a single individual or $10,980,000 for a married couple

[5] Normally the business owner themselves are the initial trustee and initial beneficiary.

[6] Such as a prohibition of sale or a specific bequest of the ownership interest to a beneficiary

[7] Iowa Code §633.383 and/or Iowa Code §633.388

[8] Iowa Code §633A.4402

[9] During the administration of the estate

[10] During the administration of the trust

[11] If the business is structured as a multi-owner LLC, upon death the membership units become NON-voting unless the beneficiary or the trust is admitted as a member Iowa Code §489.504

[12] In an intestate estate a surviving spouse gets either ALL or half of the estate Iowa Code §633.211 and Iowa Code §633.212

[13] Iowa Code §633.238, and Sieh v. Sieh 713 NW2d 194(Iowa 2006). Because the “types” of assets include both real estate and personal property (per Iowa Code §633.238(1)(a)and (c)) it is generally recognized that the surviving spouse is entitled to 1/3 of each type of property.