When you run a business, planning your estate isn’t just about signing over your financial accounts and personal possessions to heirs or completing a power of attorney and outlining medical directives.
Most people fail to realize that their business is another asset grouped together with the rest of their assets. If not titled appropriately, the business will go through the post-mortem toll booth of probate, and that is definitely not helpful to the business or the probate.
One of the most common questions from Haimo Law clients who are also business owners is: “If I die, what happens to my business?” This concern can be especially critical when you aren’t the only one involved in the work you do.
Below, we’re going to answer that question, cover other dangers of a business going through probate, and discuss how to avoid business probate problems.
The Owner of Your Business Has Died – Now What?
What happens to a Florida business after a business owner’s death depends upon two primary factors: how the business is structured and whether the owner created a succession plan. Florida courts look at both to help your survivors determine the future of your business.
Four Common Structures for Florida Businesses
Regardless of the depth of the business planning done prior to starting your company, when you registered with the state, you made decisions about the structure of your business. Over time, you may or may not have altered that structure as it grew.
Whatever the case, this basic structure becomes the foundation for how your business will continue when you’re no longer around.
In Florida, there are four general business structures. If you do not have a succession plan for your business in place, selecting the right structure is key to meeting your business estate planning goals.
What are these four structures, and what happens with each one?
Sole Proprietorship: Your Business Ends with You
A sole proprietorship is the business structure used when it’s just you. In the eyes of Florida law, these two entities — the owner and the business — are one and the same. As the owner, you are the business, and the business is you.
Essentially, sole proprietorship means that after a business owner’s death, the business dies, too. Your estate will liquidate business assets, pay all business debts, and distribute any remaining assets to your beneficiaries.
Business Partnership: Sharing Responsibilities
While there are a number of ways to structure a partnership, at its core, every business partnership usually involves a formal agreement between (or among) entities to share responsibilities, liabilities, and profits. Similar to a sole proprietorship, a partnership is not separate from its owners.
With a formal agreement, your partners are able to continue operations as well as allow for the acquisition or sale of your business interests after your death. Without it, the partnership automatically dissolves.
Limited Liability Company: Separating the Business from Its Ownership
Establishing a Florida Limited Liability Company (LLC) is one strategy utilized by both sole proprietors and partners in order to separate themselves from the liabilities associated with their business. LLCs should always have a solid operating agreement, which will address ownership, control, management, voting, allocations of profits and losses, distributions to partners, transfers of interests, divorce, bankruptcy, and disability, to name a few things.
This operating agreement typically also specifies what happens in the event of a business owner’s death. If it outlines that the business should go to and continue under surviving partners, for example, it will. If it doesn’t, however, then Florida law determines what happens next.
Corporations: The Estate Automatically Owns the Decedent’s Shares
Unlike any other business structure, when you incorporate, your corporation automatically lives on after you’re gone. When any of the owners dies, their estate becomes the owner of any shares they own in the company until the estate is closed and shares are distributed according to either the decedent’s will or intestacy laws in the state of Florida.
The Dangers of a Business Going Through Probate
All assets owned by a deceased person in his or her name are included in the estate (and some even not in his or her name). If it’s a business – regardless of whether it’s Apple, Google, Amazon, Netflix, Tesla, Disney, or a small mom-and-pop closely-held business called “Uncle Joe’s Restaurant, Inc.” – it’s included in the estate.
So, what does that mean? After a business owner’s death, the business will enter probate. Here’s why you don’t want your business going through the probate process:
Hi. Thanks for stopping by and tuning in for another dose of Bite-Sized Bits of Knowledge, where we give you meaningful information in a short amount of time.
Today, we’re jumping into what I think is a really important issue that is commonly overlooked by practitioners and your business owners. The issue is what happens when a business goes through probate. I’m more particularly talking about an incorporated business like an LLC or Corporation or a limited partnership. Not, like, a sole proprietorship that doesn’t even have a company formed.
So as you know from our prior videos, a business is just another example of an asset, and that asset gets pooled together with the other assets in probate. Probate, as we talked about, the ABCs – assets, beneficiaries, creditors – that asset has to be identified and, like I said, pooled together with the other assets and disclosed to the beneficiaries and the creditors and so forth.
The asset that’s a business is going to have a value. That value has to be reported on the inventory. That value may be a subject of conflict.
If the beneficiaries and the creditors don’t agree, you might find yourself getting numerous valuations. Valuations such that you cannot just go to a broker and say, “What is this worth, sir or ma’am?”
A valuation is an art and a science. There are companies that all they do is valuations. It’s actually quite fascinating, and I’m very intrigued by the area of that practice.
But suffice to say that’s expensive. Valuations can be expensive. They can be $15,000-20,000. Maybe five if it’s a simple business, but like $5,000 to $15,000-20,000. And you might get a couple of them because there’s competing interest here in your probate. That’s just one issue with the business being a part of the probate. It’s just one issue is the valuation, and that’s going to have to get resolved.
The second issue is that all this is public. Your estate is not private. There’s a lot of people who get to see under the hood of the business. If you want it to be private, your business be private, you better not have it go through probate and you better have it owned in another way.
So, number one, valuation issues. Number two, public. Number three, who is managing the business if you’re the controlling party and you just passed away?
If you don’t have a stellar governing document like an operating agreement or shareholders agreement, you might find yourself with a random person being appointed by the court as your personal representative – or executor in other states – running this business for you while it’s in probate.
He or she may have no experience in your business and have no relationship with the people in which he or she is managing or partnering. It’s a big problem.
The fourth thing that I’ll mention is that if you don’t have a Buy-Sell or Shareholders Agreement or an Operating Agreement that addresses, among other things, disability, bankruptcy, divorce – in this case, death – if you don’t have that, then that business is going to go to the beneficiaries of your estate and those beneficiaries will ultimately become the owners of your share of that business alongside the surviving partners.
Those partners and your beneficiaries may get along fabulously or they may not. Your partners will have a vote – likely. They will have an interest and legal rights in the business – to information, disclosures. And they’re going to probably not be the best thing for the business.
The best thing for the business probably and the best thing for your beneficiaries is that that business either pays them off and moves on or produces profits that can go back to those beneficiaries. But the last thing you want to have happen is have these beneficiaries be a part of that process if they have no business – pun intended – being part of that process.
So these are significant issues if you have a business, and I would highly recommend you never let your business go through probate. I have seen in my personal experience and in professional experience, even businesses that have very little value take a year to go through the court system, fighting over all the issues I just mentioned – and it costs a lot of money to go through that process.
Nobody’s happy with that result. So I share this with you in the hopes that you will take affirmative action to avoid it. So I thank you for stopping by and stay tuned for more. Bye.
Let’s take a specific look at several different issues with a business going through probate in more detail.
After a business owner’s death, the Personal Representative has the fiduciary obligation to administer the estate. He/She/It must identify all the probate assets, beneficiaries, and creditors and disclose same on the inventory and fiduciary accounting.
The beneficiaries and creditors all have an interest in the estate, so they are entitled to notice, and they are going to pay special attention to the business. They are entitled to know the date of death value and will certainly have something to say if it’s perceived to be undervalued.
Importantly, the Personal Representative has a fiduciary obligation to maximize the value of the estate so he/she/it cannot overlook a potentially undervalued business appraisal or accept an appraisal produced by an unqualified appraiser (or an appraiser chosen by an adverse party).
You can expect a few hearings on the subject as this issue slowly gets resolved through the court system. It’s worth noting you should get an appraisal at the time of death for tax purposes even if you avoid probate. The difference is that it’s private and doesn’t involve a lot of parties who have rights.
Remember that legitimate creditors are entitled to be paid out of the assets in the estate, which includes the business. If there are insufficient assets in the estate, then the business will be liquidated, and the proceeds derived therefrom may likely be used to settle the deceased’s creditors’ claims. What’s left will be devised to the beneficiaries pursuant to the will or via statute (if there is no will).
Consequently, all or part of the business will end up being owned by the beneficiary or beneficiaries, and it’s likely that (i) the beneficiaries have no relationship with the surviving partners in the business, (ii) the beneficiaries are not interested in participating in the business and will likely abandon the interest or want to sell their shares to a third party, or (iii) the beneficiaries will not be qualified to work the business and be more of a burden than a benefit.
Good business people execute Shareholders Agreements or Operating Agreements which address, among other triggers, a buy-back triggered by a business owner’s death in what’s called a “Buy-Sell” agreement.
Even with a buy-sell agreement, while the estate administration is pending, the Personal Representative is effectively acting as the shareholder on behalf of the business interest, and is again, charged with an obligation to maximize the value of the estate. Without a buy-sell agreement, very often your surviving business partners will not have a relationship with the Personal Representative.
In addition, similar to the risks of a beneficiary turned partner, it’s likely that (i) the Personal Representative is not interested in participating in the business and will likely abandon the interest or want to sell its shares to a third party, or (ii) the Personal Representative will not be qualified to work the business and be more of a burden than a benefit.
On one hand, the Buy-Sell Agreement will expedite liquidation of the shares and transfer of shares to the appropriate beneficiaries. It will also enable the surviving partners to continue to operate the business with less disruption, which is better for them and their families. On the other hand, it does not avoid the probate process or avoid the public nature of the proceedings.
Time-Consuming and Expensive Process
This process can take a very long time, sometimes 1-2 years, which cannot possibly be good for the business during that time. It also is quite financially draining. With valuations, hearings, and attorneys fees and costs, it could easily be over $10,000.
Further, even if the Personal Representative is very diligent, there are so many other parties that can hold it up: judges, case managers, clerks, judicial assistants, creditors, attorneys to creditors, beneficiaries, attorneys to beneficiaries, and so on.
It’s worth mentioning again that the inventory disclosing the value of the business is public record. For almost all businesses, this is not a good thing.
Here’s the bottom line: you don’t want your business going through the probate process and neither do your partners. Nobody’s more qualified to operate it than people who know the business well, and that’s not the Personal Representative and likely not the beneficiaries. It’s public, time-consuming, and there are a lot of parties involved, which makes it very complicated.
So, what can you do to avoid probate problems?
Here’s What Business Owners Can Do to Avoid Probate Problems
The good news is that you can avoid costly and taxing probate problems with a little forethought. Below are just a few examples.
Establish a Living Trust
While a will distributes assets after a business owner’ death, a living trust allows you to distribute your assets while you’re still around. The trust is already standing on its own legs, so to speak, when you pass away. This renders probate unnecessary, because your business essentially belongs to the trust.
Of course, you will want to carefully consider who you’re naming as trustee in your stead. This trustee will transfer assets to your beneficiaries according to your written wishes, all while avoiding probate.
This may seem like an obvious step, but business partners or family members working for a business may not think to make themselves official joint owners. Joint ownership simplifies the legal heritance of a business. Since ownership was already shared, it continues with the surviving owner(s). This means you can skip probate.
Many titles and bank accounts also allow you to name an automatic beneficiary to circumvent probate. You can ask for a TOD (“Transfer On Death”) form to execute this.
Business Continuation Plan
For most entrepreneurs and business owners, a primary driving force behind the work we do is to build a legacy we are proud of — something we can pass on to our successors.
And while the structure you establish for your business will certainly govern the way it is handled, there is an additional (often neglected) business planning tool that can further ensure your business is passed on exactly the way you would have hoped: your business succession plan.
A succession plan is an outline of how an owner wants to transition the leadership of their business. For some, that means in retirement. For others, an illness may be a catalyst. And every plan may be implemented upon the business owner’s death.
Some of the most common elements addressed in a succession plan include:
- Anticipated timing of the transition
- Named successor(s)
- Business valuation and tax planning
- Communications with staff, clients, and family
- Provisions for implementing the plan
On top of these steps, you can create a larger business continuation plan. This plan should cover as many details as possible so that few questions remain after you’ve passed away.
It may entail a buy-sell agreement, the establishment of joint ownership as mentioned above, a gift of stock, or other arrangements. You’ll want to outline who will manage the company, plus a budget to pay off debts and execute your plan.
While this may not allow the new business owners to skip probate entirely, getting specific can streamline the process. The budgeting step is crucial, as a probate judge may order the liquidation of a business to pay off debts if the funds don’t balance out.
Seek Legal Help
We’re taught that “a stitch in time saves nine,” and that lesson applies to business estate planning, too. Invest in these up-front strategies that will keep probate court brief and uncomplicated — or even allow you to skip it altogether.
Ultimately, if you wish to exercise maximum control over the future of your business, the key is having it written down. Reviewing your documents annually and working with an experienced business estate planning firm are two of the biggest steps you can take in the right direction.
If you are a Florida business owner with questions about whether your current business structure is one that will help you meet your business goals, or if you need help developing a solid succession plan, reach out to Haimo Law for advice.