What Happens When a Business Owner Dies? Three Steps to Cheat Death

Monday, March 9, 2020

When you’re dead, you’re dead. What happens to your business, however, will be whatever you planned for. What!  No plan? That can be chaos for your family, business associates and the business itself — a completely avoidable mess. Don't expect to be remembered fondly. You should not feel alone, however.  Fewer than 30% of small business owners have a succession plan. When a business owner dies without a plan, what happens next depends on the structure of the business. Dodging death? That’s someone else’s department.  But you’re an entrepreneur. You can determine what happens to your business. Take these three steps:

  • Step one – work with an attorney to create a result that you intend.
  • Step two – determine a business structure that suits you for tax and liability purposes.
  • Step three – craft the details of succession planning within that structure.

When a Business Owner Dies Without a Plan, Business Structure Governs

Sole Proprietorship.  In a sole proprietorship, the business and the owner are essentially the same.   If Sue, the sole proprietor of Sue’s Shoppe dies, so will the Shoppe.  Sue’s estate will liquidate the assets of the business to pay off the business debts, and anything remaining will be distributed in accordance with Sue’s will. Sue had a will, right?  If she had no will the distribution happens in accordance with state probate law.  There will be no continuing income from the business and, if the debts were substantial, there may not be much to distribute to her heirs.  The result could be awful. Nothing’s left.

Corporation or S Corporation.  Corporations do not die when a business owner dies. On Sue’s death, her estate would become the owner of her shares.  If Sue were the sole shareholder or the majority shareholder, the new owner of the business would be her estate, as above, at least until the estate was closed and the stock distributed as provided by will or intestacy laws.  Much the same would be true if Sue had structured her business as a subchapter S corporation.  If Sue’s spouse or beneficiary has always been involved in the business, this could be fine. But it might be awkward if her heirs had no involvement or interest in the business.

Limited Liability Company.   LLCs are organized under the terms of an operating agreement, which should specify what will happen in the event a member dies. If the operating agreement allows for continuation on the death of a member, new members can be admitted upon a vote of the remaining members.  If the agreement is silent, state law will determine what happens when a business owner dies, and many states default to dissolution and distribution of the assets.  It may make a difference whether Sue was a member-manager with an active role in running the business or whether she had a simple membership interest.

Partnership, Limited Partnership or Limited Liability Partnership.  If Sue and Ted were general partners but did not have a formal partnership agreement, Sue’s death will legally dissolve the partnership, and all business activity will stop except for the steps necessary to wind up the partnership.

The business need not die, however, under the terms of a partnership agreement.  One of the great strengths of LPs and LLPs (and LLCs, for that matter) is that their formation requires a written agreement, which gives everyone a reason to talk about this difficult issue.  An agreement, even in the case of a general partnership, can provide for the sale or purchase of a deceased partner’s interest, set a price and provide for life insurance to fund the purchase and ensure the continuation of the business.

Have an Exit Strategy

It’s like going to a holiday dinner at the relatives’ house.  Before you accept the invitation, tell everyone when you have to leave. You can always linger if you’re having fun.  They’ll only be flattered, but you can go when you have to go.

In this case, that means sitting down with a business attorney and, as part of a large discussion that also covers liability issues and tax planning, define your goals.  Do you want to sell the business so you can buy that vineyard in Sonoma?  Is it important to ensure that the business continues?  What is your appetite for tax and personal liability risk?  Would your situation be better under an LLC or an LP?  Is ensuring a continuing income for family members your primary concern?  Of course, in addition to being intentional about business structure and crafting within that structure, you will certainly need a will.  Don't do this by yourself.

By Nasir Pasha, Esq. for Pasha Law PC