Business succession planning is estate planning

The final season of HBO’s “Succession” racked up six Emmy Awards earlier this month. While the tale of the fictional Roy family made for some great television, the one thing you most want to avoid in a real-life succession plan is outstanding drama.

For owners of closely held small businesses, succession planning is a crucial part of the overall estate plan. A properly crafted estate plan is essential to ensure the smooth continuity of the business in the short term and its overall success in the long term. But many succession plans don’t address the potential sudden, unexpected death of a business owner.

Map Out a Comprehensive Plan

The operating agreement or shareholders’ agreement should spell out exactly what is to occur in the event of the death of a partner. Such agreements often don’t adequately set forth a proper clear succession plan or are not entirely in concert with all partners’ wishes.

The governance documents might simply allow the business to pass outright to surviving heirs. This is a fine result, if that’s the intention of all partners; however, it’s typically an unwanted consequence of poor planning. Estate planning documents, whether a last will and testament or trust, should contain provisions that align with, or that defer to, the business governance documents. This helps avoid potential conflicts between the surviving business partners and the surviving heirs.

Avoid an Unwanted Partnership

Not many people would be too keen on becoming partners with a deceased partner’s surviving spouse or children that weren’t previously involved with the business. Partners should have a buy/sell agreement in place. It can be a standalone agreement, or it can be terms incorporated into an operating agreement or shareholders’ agreement.

These provisions should clearly set forth the buyout terms, timing and valuation formula to determine the price. The will or trust of the deceased partner — depending on how equity was owned — should refer to and not contradict the business documents.

If there are no governance documents in place, or if they are silent on this issue, then the estate planning documents may contain default provisions authorizing the executor or trustee to sell the interests to the surviving partners at fair market value.

Liquidity Provides Options

If the business has sufficient liquidity, one option is to continue operations while simultaneously buying out the estate of the deceased partner. If that’s not doable, or if the preference is to keep the operating capital invested in the business, another consideration is having insurance policies on the lives of the partners.

These policies would be owned by the business, or a trust, and the proceeds would provide liquidity to pay off the deceased partner’s estate in return for their equity being divided among the surviving partners.

In some instances, governance documents would allow surviving partners the option to buy the equity directly from the estate. If there is no insurance, or if the proceeds are insufficient, then the buyout terms would typically allow for a combination of a down payment with the remainder to be paid by way of a secured promissory note.

Keeping the Peace in the Family

Another common situation is when the sole remaining partner wants to transfer ownership to the child mostly involved in the family business, while being fair to the other children. While it’s logical to leave the business interests to the children involved — whether by lifetime gifting or distribution at death — there are various ways to use estate planning documents to keep the peace among the siblings.

A time-honored technique is to have an equalization clause in the documents, the mechanics of which would cause the children inheriting the business to receive less of the other assets or residuary estate. If the value of the business is greater than the residuary estate, then a life insurance policy should be in effect that would provide cash to the children not involved in the business as compensation for equity they would have received.

Of course, this is only the tip of the asset divestiture iceberg. Depending on net worth, there are several effective strategies and vehicles to govern and preserve assets and transfer wealth to the next generation while minimizing estate tax exposure.

Create Lasting Success

Small businesses account for about 70% of global employment. According to PwC’s 2023 Global Family Business Survey, nearly two-thirds of family businesses don’t have a clearly documented succession plan.

Battles rage every day in probate courts involving businesses with owners that didn’t understand the importance of getting the succession plan right. Don’t find yourself in that role. You won’t win an award for having the proper succession plan in place, but you will avoid the drama.

Sebastian D’Acunto is a partner in the trusts and estates practice at the law firm Pullman & Comley with five offices in Connecticut including Bridgeport, Stamford and Westport, as well as White Plains.