Business owners require estate planning and lifetime planning as well.

Choice of Business Entity

The first step in starting any business is considering a proper choice of business entity.  Each has advantages and disadvantages. The type of entity will vary in each circumstance and an attorney should assist in choosing the business type.  Choices include the following:

  • Sole Proprietorship.
    • Advantages.  Simplicity and control.
    • Disadvantage.  Liability.
  • Corporation.
    • Advantages.  Limited liability, potential tax benefits, control can be retained or transferred.
    • Disadvantage.  Filings required and possible double taxation with an ordinary corporation
  • Limited Liability Company.
    • Advantages.  Limited liability, potential tax benefits, control can be retained or transferred.
    • Disadvantage.  Filings required.
  • Partnership.
    • Advantages.  Limited liability, potential tax benefits, control can be retained or transferred.
    • Disadvantage.  Filings required.
  • Limited Liability Partnership.
    • Advantages.  Limited liability, potential tax benefits, control can be retained or transferred.
    • Disadvantage.  Filings required.

When choosing a business entity, estate, gift and income tax issues must be considered.  The choice of business entity should be designated to insure that control is maintained for as long as desired.

Tools for Estate Planning for Business Owners

Certain documentation is required for most business entities.

    • Entity Selection.  After a choice of entity has been decided upon, appropriate documentation must be filed with the State office having jurisdiction, except in the case of a sole proprietorship.  Even then, a fictitious name certificate should be considered.
    • Internal Documentation.  Internal documentation is required, including an operating agreement, partnership agreement, or by-laws depending on the entity form.  The internal document may provide not only for the day to day management of the company but should also include the succession plan and provisions such as a buy-sell agreement.
    • Buy-Sell Agreement.  This is an agreement among the business owners as to how the business will be valued and what will happen in the event of the death, retirement or disability of one of the business owners.  Important sections include:
      • Issuance and endorsement of shares or membership certificates or partnership units
      • Restrictions on transfers
      • Determination of valuation
      • Mandatory purchase on death of shareholder
      • Optional purchase upon termination of employment for reasons other than death
      • Stock pledge
      • Personal guarantees of corporate obligations
      • Modification and termination of agreement
      • S Corporation status
      • Miscellaneous provisions
      • Provisions relating to life insurance
    • Employment Agreement.  An employment agreement provides for compensation and duties of a business owner employed by the business entity. Important provisions include:
      • Compensation
      • Duties
      • Vacation
      • Termination
      • Employer’s authority
      • Records
      • Expenses
      • Reimbursement of disallowed compensation and expenses
      • Military service and disability
      • Term
    • Medical Reimbursement.  If the business entity adopts a medical reimbursement plan, an agreement to that effect should be prepared.
    • Written Succession Plan.  Each business plan should include a succession plan which provides for how the owner will leave the business either at retirement or upon his disability.

The Importance of Business Succession Planning

Business owners should take steps to ensure that there is a plan for the business in the event of their retirement, death, or disability.

Succession Planning should be considered at the time the business is formed and provisions should be included in the original business entity documents.  However, as in case study #1, the plan should be annually reviewed and updated to avoid any mishaps such as a failure to plan for a disability or a poor valuation formula where either shareholders or their loved ones are forced to take less than their interest is worth or become involved in a court battle to overcome a low valuation.

Business owners designing or updating an estate plan should review their succession planning.  For business owners nearing retirement this is a particularly critical issue.

The Difference Between Business Succession Planning and Estate Planning

Business succession planning defines certain events triggering sale of a business interest.  These generally include death, retirement or permanent disability and the plan and related documents provide a mechanism for the purchase of the business interest of an owner who dies, retires or becomes permanently disabled.  The business interest can be purchased by the business entity or by other business owners.  If there are no other members of the business entity, a business succession plan would include efforts to find a buyer.

Business succession planning and estate planning should be done in conjunction with each other.  In actuality, the business succession plan is a part of the overall estate plan and consideration should be given to the effect of the business plan on the estate plan.  Both the business plan and estate plan must be reviewed regularly to be sure they are kept up to date.

As the son takes over the business during his lifetime, how will the wife be taken care of?  Or, if the father dies and leaves all his assets to his wife, how will the son’s place in the business be preserved?  How will the father provide for his daughter?

Failing to do business succession planning and estate planning together may result in an unsatisfactory disposition of the assets or result in expensive litigation and fractured family relationships.

What Issues Need to be Considered Before Planning

The first thing required for business planning is a vision of the future of the business.  Will it grow?  Will it stay the same size?  Will one or more children take over the business?  Will the business be sold to a third party or will the business end on the death, disability or retirement of the business owner?  How does the income from the business fit into the business owner’s personal financial plan?  Is it a significant source of retirement income for the business owner or his spouse?

Replacement Income

If the business is the main source of income for the business owner and/or his spouse, there are a number of options with respect to planning for succession.

Salary Continuation Plan.  One option is a salary continuation plan where the business agrees to pay some of the owner’s salary in a later year than when it is initially earned.  By doing this over a number of years a reasonable salary may be received in retirement. The agreement is an enforceable contract but may be evidenced with an unsecured promissory note.

Retirement Plan.  Another option is a qualified pension, profit sharing plan, SIMPLE, SEP IRA, or KEOGH.  This may provide a reasonable retirement compensation at a favorable tax basis and the company may take a tax deduction for the contributions it made when the plan was made.  Since the plan is not a taxpayer, income on contributions is earned tax-free but is taxed upon distribution.

Structured Payout.  If the client plans on selling his business, the client may consider a structured payout over a period of years.

Separate Business Entities.  Many business owners opt for separate business entities, one which holds the business and one which holds the real estate.  The entity with the real estate then leases it to the business.  The client may wish to retire from the business but keep the entity with the real estate to help fund the business owner’s retirement.

Family-Owned Business

Where there is a family-owned business there are special circumstances to be considered.  Family business owners rank the issues that confronted them in the following descending order of importance:

  • Organizational structure of the business
  • Capable and supportive key management
  • Motivation of successors and management
  • Accommodation of family members
  • Estate planning
  • Retirement planning for current management
  • Retaining competent professional advisors
  • Operating with a board of outside directors

Selecting the Successor Owner/Manager

If the business owner has a specific individual in mind to take over the helm of the business, be it a child, relative, or extraordinary employee, begin planning and grooming that person for succession now.  Consider transferring control of the business to the desired successor during the business owner’s lifetime and taking an advisory position so that the chosen individual can get used to running the business but the founder’s knowledge and experience is available for the new person during rough times.

The person to own the business is not necessarily the best person to manage the business.  The business owner must consider these two roles and decide who should be owner and who should be manager.

Treating Children Equally

If one child or children participate in the business and others do not, it is challenging to treat the children equally.  Often one child has worked for years in the family business expecting to take over at some point but there are relatively few other assets to provide for the other children.  One way to plan for this is to purchase a life insurance policy effective at the death of the second parent.  Using life insurance will reward the child who has worked in the business for their “sweat equity” and will still provide equal amounts for other children.

Planning for the retirement, disability or death of a business with multiple owners

Buy-Sell Agreement.  As in case study #1 the best way to plan for a business owner’s retirement, disability or death when there are multiple owners is likely to be a “Buy Sell Agreement.”  There are three common types of buy sell agreements, a redemption agreement, a cross purchase agreement, and a hybrid of the two.

Redemption Agreement.  The redemption agreement is a contract between all the owners and the business where the owner agrees to sell his interest in the company back to the company at an agreed upon price (usually based on a formula rather than an exact figure).  If the owner wishes to sell to a third party, the redemption agreement generally requires that he first offer the interest to the company and if the company refuses to buy, then the interest can be sold to a third party.

Cross-purchase Agreement.  The cross-purchase agreement is generally a contract among the owners in which the exiting owner (or estate) offers to sell his interest to the remaining owners at a specified price (again based typically on a predetermined formula)

Hybrid Agreement.  The hybrid agreement is usually between the entity as well as the owners and provides for either the entity or the remaining owners to purchase the exiting owner’s interest.  In many cases agreement requires that the owner (or his estate) offer the interest first to the company and if the company refuses the purchase, then the other owners may purchase the interest.

Life Insurance.  If the company or the owners have illiquid assets then funding such agreements with appropriate life insurance is a possible way to fund the agreement.

Installment Sale.  Life insurance may not be a satisfactory way of purchasing the business interest from a disabled or retiring business owner.  In those cases, an installment sale may be required.  Under an installment sale the remaining business owners pay a lump sum shortly after the disability retirement of one owner, and periodic payments thereafter.


In addition to succession planning, be certain to follow all business formalities such as filing annual reports with the State Corporation Commission, paying annual dues, filing a tax return, and having annual meetings.  Failing to do so may be considered evidence that there is not a formal business.  That can call into question issues such as valuation of the business, any favorable tax positions, and may leave business assets open to individual creditors.

Following the corporate formalities and having an annual meeting will ensure that the original plan put into place is reviewed and updated as required.  As in case study #1 failing to update can leave the business owner and his family in a precarious position.

Important steps that must be taken are:

  • Annual meeting of shareholders, members or partners
  • Minutes of annual meeting of shareholders, members or partners
  • Board of Directors’ or Managers’ meeting
  • Minutes of Board of Directors’ or Managers’ meeting
  • Adjustment of valuation agreement if the buy-sell agreement so provides

Annual Meetings

After the business owner’s estate plan and business succession plan are in place the business owner should meet yearly with his attorney, accountant, and any other professional advisors to review and update his plan as necessary.

Written By Thomas D. Begley, Jr. for Beyond Counsel an Estate Planning Software Company

©2018 Beyond Counsel, LLC.  All rights reserved.

            Business Succession Planning that Meets the Owner’s Needs, Daniel H. Markstein, III, Estate Planning Magazine, July 2006, Vol. 33, No. 7,. p. 22.

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