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Today's To-Do List: Create a Succession Plan for the Unexpected

Succession planning for family businesses receives a deserved amount of attention, but the focus tends to be on getting the next generation ready to take the reins. What happens if you pass away or are incapacitated due to illness or injury? In that case, the actual nuts and bolts of the transition can be even more important.

According to Steve Hartnett, J.D., LL.M. and Associate Director of Education at the American Academy of Estate Planning Attorneys, "Many business owners don't have a succession plan that covers the unexpected," he says. "Then, sadly, the business often dies with them."

Succession planning where company ownership is concerned can be fairly complicated, so make sure you get advice from an experienced estate planning attorney. But at a simple level every plan is based on two basic issues. You've probably thought a lot about who will take over for you; that's one. But, just as importantly, how can you make sure what you want to happen will actually happen? Without the right short- and long-term plans in place, it won't.


Long-Term Planning
Let's start with long-term succession planning. (Hopefully you won't need a short-term succession plan, but we all need a long-term plan.)

Say you own a business. You have three kids. The business makes up half the value of your estate. Also:

  • Your daughter is involved in your company and you intend for her to eventually take over
  • Your two boys want no part of the business
  • You intend to leave an equal share of your estate to each of your three children
Right away there's a problem. In most states, if you pass away without an effective estate plan in place, each child will typically receive an equal share in the business. That means company ownership will be split three ways. Or, depending on your marital status, your spouse may receive 50% of the company with your children splitting the remaining 50%.

In either case it doesn't take a psychologist to predict the effect on your business or on family dynamics.

If, on the other hand, you aren't married and you leave the business in its entirety to your daughter, your boys will not receive an equal share in your estate.

It's also not hard to predict the mood around the Thanksgiving table if that happens.

So what can you do? Life insurance could be a simple solution. Say your business is worth $1 million and you also own $1 million in assets outside the business. Purchase a life insurance policy worth $1 million and make your boys equal beneficiaries. Then leave the $1 million business to your daughter and half of your non-business assets to each son. The life insurance policy makes up the difference, everyone gets an equal share, and Thanksgivings are safe.

But keep in mind an accurate business valuation is absolutely critical. "The most difficult part of the plan is usually putting a value on the business," says Gerald Dunworth, a partner at the New York law firm Gibney, Anthony & Flaherty. "This is important for two reasons: 1) the individuals in the family who do not participate will often think mom and dad gave the business siblings a big gift, and 2) the value will have to be justified to the IRS if an estate tax return is required."

Life insurance policies can also be a straightforward way to deal with the sudden death of a partner. In your operating agreement, include a buy-sell clause and have each partner take out a life insurance policy, naming the other partner the beneficiary. If one partner passes away the insurance proceeds can be used to purchase the deceased's share of the business.

"Also keep in mind life insurance can be a great non-business estate planning tool," says Steve. "If you have more than one child and want to leave your home to one child, a life insurance policy could be a way to make sure your heirs won't have to sell the home in order to create equal shares of the estate."


Short-Term Planning
Ownership issues aside, who will run the business on a day-to-day basis if you are incapacitated? What if major decisions need to be made like selling or purchasing assets or arranging financing? You may be the only person with the authority to make certain transactions. In that case, a guardian might have to be appointed to take over your affairs, and guardianship can be a time-consuming and all-too-public legal process.

One option to try to get around guardianship is to set up a Power of Attorney that allows your agent to act on your behalf under specific circumstances. (You get to decide the circumstances and the scope of the authority granted.)

A better option is to set up a Trust, place the business in the Trust, and enable your successor trustee to step in and manage the assets of the Trust. Also, when you pass away the Trust can specify whether the business goes to your spouse, to your child(ren), into a Family Trust... whatever you decide.

A Trust Is Often Your Best Option
"A Will is not an inherently bad estate planning vehicle," Steve says. "But keep in mind that if you have a Will, anything you own individually, including your business, must go through probate."

Probate is a long, slow, sometimes expensive, and very public legal process. Business valuation may be involved, potentially exposing trade secrets, sales figures, customer information, etc. A Trust, on the other hand, does not require probate and therefore maintains confidentiality and privacy. Think of a Power of Attorney as a band-aid and a Trust as a more flexible and longer-term cure.

"Whether for your business or for personal needs," Steve says, "compared to a Will, a Trust provides greater flexibility and privacy."

Photo courtesy flickr user Matt Lehman, CC 2.0

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