How to Plan for the Death of a Business Owner

Regular readers of Practical Ecommerce may have noticed that my legal posts have been missing for several months. I wish I could attribute the long absence to a vacation. But, unfortunately, I cannot. The combination of a busy travel schedule and the death of my mother has kept me from writing this column.

But these have also given me time to reflect on my own preparedness for life’s unforeseen events. With this post, my hope is that others can learn from my experience and better protect their businesses and families.

Business Survival

Like most business questions, the first place to look to determine if you are prepared is within the governing documents of your business entity. The actions of a corporation are governed by its bylaws, and the actions of a limited liability company are governed by its operating agreement.

Since my law firm is a limited liability company, and because LLCs are the most modern and common form of business entities, I will focus on operating agreements. With that said, the analysis that follows applies to both corporations and LLCs.

… the first place to look to determine if you are prepared is within the governing documents of your business entity.

Every operating agreement should contain provisions to deal with the death or permanent disability of a member. In the case of my law firm, our operating agreement states that the death or permanent disability of a member triggers an immediate offer to sell the membership interest of that member. Permanent disability occurs where a member has a physical or mental impairment that substantially limits one or more life activities and is expected to continue for six months or the remainder of the member’s life. As such, short-term disability does not trigger an automatic sale.

Why does death or disability trigger a sale instead of giving the membership interest to the heir of the deceased or disabled person? There are two primary reasons. First, non-lawyers cannot own a membership interest in a law firm. So, in my case, passing the membership interest to my wife wouldn’t work.

Second, I doubt that my partner wants to be in business with my wife. Though she is lovely and highly intelligent, she doesn’t know how to run a law firm. And if you are taxed as an S corporation, there may be even more reasons to avoid transferring membership interest to an heir: It could violate your S-corp status.

Though death or permanent disability triggers a “sale,” it does not mean that the business needs to be worried about its cash flow. To provide our law firm with the financial means to support such a sale without affecting the viability of the business, we have obtained an insurance policy on each member.

Therefore, death and disability not only triggers the sale provisions of the operating agreement, but it also triggers the insurance policy to pay for the business’s repurchase of the deceased or disabled member’s membership interest. Upon my death, my wife will receive a nice payout that is paid, at least in part, by our business insurance policy.

Family Protection

But that isn’t the end of preparations. In the absence of an estate plan, my personal assets could end up in probate court. To avoid the time and expense associated with probate proceedings and to protect the interests of my wife and child, we hired an estate attorney to create a few important documents (yes, attorneys hire attorneys).

First, our estate planning attorney created a trust to manage our assets during our lifetimes and to distribute our assets after our death. When my wife and I die, our family trust ensures that our assets pass to our child and are utilized to support her and her education. Our child is provided with only limited access to the financial assets of our family trust before the age of 18, to protect against stupid decisions. After the age of 18, she has full access. All of our major assets have been transferred to this trust, including our home.

Our estate planning attorney provided us with wills that control the distribution of our assets after our death and that transfer those assets to the trust. Our attorney also supplied two key forms: designation of patient advocate and durable power of attorney. The designation of patient advocate form, in my case, assigns my wife as my patient advocate to make care, custody, and medical treatment decisions for me if I am incapacitated. And the durable power of attorney form designates my wife as my power of attorney if I cannot undertake a specific legal action myself.

The Inevitable

This is not a full analysis of the steps that a business owner should take to prepare for his untimely death or disability. I hope, however, that my situation has provided some insight. More importantly, I hope it spurs you to act to protect your business and your family. I hate to break it to you: We are all going to die.