Planning for Business Owners

In our previous blog we touched on how planning for clients with a variety of assets can be more challenging, or at least provide the opportunity to make use of more interesting planning strategies. One situation where this is especially common is when the client owns a family business. When that is the case, the relationship between the business and the beneficiaries is a lynchpin in the planning.

Michael and Nancy own a series of businesses, originally inherited from Nancy’s parents and then expanded, that over the years have allowed them to provide very well for their three children Oliver, Pam, and Quinn. All three children are now adults with children of their own, and Michael and Nancy have assisted them with funding their grandchildren’s college costs. Pam is very active in the family businesses, ready to step in and take over control whenever her father is ready to retire. While Oliver and Quinn are not involved in the businesses, Oliver has become a successful CPA and is doing well on his own. Quinn on the other hand has struggled to find her way in the world. A recent divorce has left her in a precarious financial and personal situation.

Adding to the complexity of planning for Michael and Nancy is that a section of their business is very reliant on the work on a particular key employee without whom that portion of the business is likely to suffer. The employee also has expressed interest in owning part of the business. While the complexity of this situation cannot be explained in the confines of our normal word limits we will summarize how proper estate planning can be used to ensure that Michael and Nancy can provide for Oliver, Pam, and Quinn equally, address concerns about differing financial states, and avoid creating a competitor.

First, it is important to note that much of the planning for Michael and Nancy’s situation revolves around the use of a document called a Buy-Sell Agreement (Buy Sell). This document creates an obligation for the owners of a business to sell and a particular party to buy the business under certain predetermined circumstances. The Buy Sell will establish the triggering events (often Death, Incapacity, and/or Retirement of the seller), the sale price (or at least how that price will be determined), and the terms for paying the sale price. Depending on the relationship between the buyers and sellers, there may be a life insurance component to the Buy Sell that guarantees there will be funds for some, if not all, of the purchase price.

For Michael and Nancy we used two different Buy Sells to achieve their goals, one with their daughter Pam and one with their key employee. For the key employee the Buy Sell granted an initial sense of ownership in the part of the business in which he was involved, and guaranteed him the right to buy out that portion of the business when Michael and Nancy retired or passed away. The Buy Sell even included incentives to encourage the key employee to improve the business while Michael and Nancy remained the owners, increasing profits in the near term without significantly increasing the final purchase price. This Buy Sell was part of the planning to create sufficient liquid assets to allow Michael and Nancy to make Pam the sole owner of the remainder of the family business while still having assets to leave to Quinn and Oliver.

In addition to the funds from their key employee’s Buy Sell, Michael and Nancy created a Buy Sell with Pam which controlled the transfer of the majority of the remaining family business assets. Michael and Nancy funded this Buy Sell with the proceeds of a Second to Die Life Insurance policy on Michael and Nancy’s lives that provides the business with the funds to buy Michael and Nancy’s interest in the company from their Living Trust, leaving the Trust with liquid assets to distribute to Oliver and Quinn. In lieu of those liquid assets, Pam will receive her parent’s voting interest in the company, giving her complete control of that asset.

Since the liquid assets for Oliver and Quinn will pass through Michael and Nancy’s Living Trust, they were able to provide their Trustee with the discretion to hold distributions to Quinn in trust in the event the Trustee deemed that she needed additional assistance with the large influx of money. While this creates a situation fraught with potential problems because Michael and Nancy named Oliver as the first successor Trustee, the family dynamic between Oliver and his “baby sister” is strong and Michael and Nancy are comfortable with the situation.
This example touches on the simplest use of a Buy Sell and does not address many of the other strategies available to business owners for transferring wealth to their beneficiaries but clearly, the complexity of even this simple plan requires the involvement of other experienced professionals. As always, do not attempt to implement the strategies you read about here without consulting an attorney experienced in the estate planning field.

Matt and Al