You may not have considered what happens to your business if you or one of the other owners dies. You may think that the possibility of that happening is slight, or there may just be more pressing issues in the short term (particularly if you’re starting up).
However, continuity on the death of an owner is something to plan for. People do die before retirement or sale and what happens afterwards isn’t always straightforward. If you have a stake in a business, you’ll want to protect the value of it as well as the income you earn from it.
The three things you need to decide are: who owns the deceased person’s share, who controls that share, and how the business continues.
Ownership is important because it is likely to affect how easily the business can be sold. Your exit plan may rely on the co-operation of other owners to sell.
Who inherits the share of the business depends on the deceased person’s Will. If there is no Will, then who inherits is decided by law under ‘rules of intestacy’.
A Will is a private document, which can be changed at any time. Business partners may be able to encourage another partner to make a Will or to change a Will so that a business is treated in a certain way, but no-one can legally oblige someone else to leave their business to a particular person. So you can’t rely on a promise to make or change a Will.
Ownership may also pass to multiple people.
Additionally, there may be circumstances in which assets have to be sold to pay debts. If a home has been left to a spouse free of a large mortgage, to repay the mortgage to enable this gift, the share of the business may need to be sold.
Control is related to ownership, in that whoever owns the business usually has some control over decision making.
The person who inherits the business (and thus who is given a say in the decisions) may have no experience of the business or may have no interest. That person may also not get on with the other partners as well as the deceased partner did.
Additionally, control may be separated from ownership. If a young person inherits the business, the law may require the business to be held on trust until he or she is older, and trustees may control decision making. Just like the beneficiary, the trustees may have no experience in business.
The most obvious risk to continuity is if the person who dies couldn’t easily be replaced. If a business is dependent on an owner, there will be problems if the owner dies.
There are also risks for others in the business. For example, if there is inheritance tax to pay on the estate that requires the business to be sold to pay it, jobs may be at risk. The value of the business may also be diminished if future prospects are not bright.
If the business has taken out a loan secured against the assets of the owners, if those assets can no longer be used as security for the loan, the lender may call in the loan. Without financing, the business may hit hurdles.
How to reduce the risks
Acknowledgement is an essential first step. Every owner should be aware of the risks if he or she dies, and if a fellow owner dies. Owners should plan together as to what happens.
Part of the solution is for each owner to make a Will. By placing the business in trust, with separate, experienced people as trustees (perhaps one or more of the other owners, plus a trusted family member), good decisions can be made that keep the business going in the short term.
In the longer term, the usual solution is for the other owners to buy out the share of the business from the estate. However, a clean buyout requires cash, and the surviving partners may not have sufficient cash to hand. So what owners can agree to do is to take out an insurance policy (either by the business or individually, depending on which is more tax efficient) that insures against a key man dying. This also requires ‘cross option’ rights to be given to the owners (either in the shareholders’ agreement or the partnership agreement) to buy out the share of the deceased. Insuring against the risk is, of course, an expense, but the reduction in the value of a business that is struggling to continue to trade is usually much higher.
A little amount of planning while you are all alive can allow a business to be a successful, ongoing legacy of the deceased.