IT’S ALL ABOUT CONTROL. Estate Planning vs. Succession Planning

We recently had a death in our family, and as a business owner, it has made me stop and think.  Being an attorney, I know the importance of estate planning.  My husband and I have our documents in place to take care of our children and our property if something were to happen to us.  This was done before I was a business owner.  Now, there is an added layer I need to consider, and I’ve recently stopped to think about what happens to my business upon my death.  Because this topic is so important to small business owners, this post gives an introduction on what small business owners need to be thinking about.

ESTATE PLANNING VS. SUCCESSION PLANNING

There’s a difference between estate planning and succession planningEstate planning deals with your personal will, trusts and advance directives – which address your personal property upon your death (and some other end-of-life medical issues).  Estate planning does not necessarily address the continuation of your business.

Here’s how it works.  If your small business is a corporation or an LLC, your ownership in that business entity (stocks or interest) needs to be considered in your estate planning documents.  For example, if you own a corporation, your stock in that corporation can be passed to your heirs in accordance to the directions in your will.  Estate planning determines who gets ownership of your property when you die – and the corporate stock or LLC interest in your business is a part of your property.  If you are a sole-proprietor, your business assets are your personal property and will be passed according to your estate plan.

Succession planning, on the other hand, deals with how your business carries on after your death.  It can, but does not have to, deal with who owns the business after your death.  But the reality for small business owners is that succession planning often does involve an ownership component.  Having a succession plan means that the business has a way to continue operating after the death (or retirement) of its top manager (or one of the top managers).  For small businesses, the top manager is often the owner.
This is the reason why estate planning and succession planning should be considered together for small business owners.   There are several scenarios for how this usually plays out:

#1           Heirs Manage.

When we refer to “heirs” we usually mean whoever is named in the will (or sometimes a trust) as the new owner of the property.  In this scenario, the business owner dies and her ownership in the business is passed to her heir or heirs through an estate plan. The heirs in this case have the ability and desire to step in and manage the business to keep it going.  If the heirs were not previously involved in the business, there could be a significant learning curve and a period of decreased revenues as a result.  Thus, the succession plan in this scenario may or may not be adequate to keep the business thriving, depending on the qualifications and knowledge of the heirs.

Estate Plan = Ownership of business is left to heirs.

Succession Plan = Management of business will be taken over by heirs.

#2           Heirs Sell.

In this scenario, the business owner dies and his ownership in the business is passed to his heir or heirs though an estate plan.  However, his heirs do not have the desire or the knowledge to manage the business and they want to sell it.  Often, a business broker is enlisted to help sell the business to a new owner.  While this scenario can bring in cash to the heirs upon the sale, there is often a decreased value in the business due to the time lapse between the business owner’s death and the purchase by a new owner.  There can also be a resulting decrease in business value if the business was heavily reliant upon the personal skills of the deceased business owner and/or procedures were not documented for someone to easily step into his shoes.  If the business cannot be sold within a certain amount of time, the heirs are usually forced to shut down the business and they consequently lose the value of that property.  This is a worst-case scenario for any business owner who has worked hard to grow their business and create financial security for their family.

Estate Plan = Ownership of business is left to heirs.

Succession Plan = None.

#3           Co-Owners Manage.

If the business is owned and managed by more than one person, the co-owner(s) can continue the management of the business.  The deceased owner’s ownership interest can still be passed through her estate plan to her heirs, but the heirs do not have to manage the business to keep it going.  The co-owners carry on the business and the heirs receive any profit distributions that are paid out.  This is a scenario that often happens when co-owners of a business have a close personal relationship with each other.  Upon the death of one, the others are willing to work in the business and be business partners with the heirs.  With relationships that are not that close, this scenario does not end up working very well.  The surviving co-owners can sometimes feel imposed upon for working longer hours, having more responsibilities and/or having the added expense of hiring someone to pick up the deceased owner’s duties.

Estate Plan = Ownership of business is left to heirs.

Succession Plan = Co-owners carry on management.

#4           Co-Owners Buy.

In this scenario, when one of the business owners dies, his ownership in the business is passed through his estate plan to his heirs.  Either the heirs or the surviving co-owners (or both) don’t want the heirs to be owners of the business. The co-owners buy the ownership from the heirs – usually through a pre-arranged agreement called a Buy-Sell Agreement.  The price and terms of the buy-out are already established, and upon the death of one of the owners, the process just needs to be followed.  The heirs receive a payment, and the co-owners maintain ownership of the business.  The timing of this scenario is relatively quick so that the impact on the business is minimal.

Estate Plan = Ownership of business is left to heirs.

Succession Plan = Buy-Sell Agreement.

While the four scenarios above are outlined in a very general sense, for service professionals like me who are licensed or require specialized knowledge to run their businesses, there is an added layer of complexity.  As I am discovering, it is best to take the time to think about a succession plan along with your estate plan.  Getting all of the details planned out in advance can alleviate the stress on your heirs during a time when they will be grieving.

Keep in mind, you don’t have to recreate the wheel – there are professionals who can help you through this process. A business attorney, an estate planning attorney and a business broker all deal with these issues on a regular basis.  Reach out to one and ask how you can get started.  You’ll feel better once it’s done … and you’ll be in control.

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This blog post is offered for informational purposes only and is specific to Florida law. For individual advice, please contact a business attorney to discuss your particular needs.