The day-to-day requirements of running a business—including a law practice—keep owners busy. But taking some time to plan for an emergency or ownership change can pay off. If an owner stops running the business, will it close, or will it continue to run? Who will run it? Here are some tips to plan for what happens to the business, as well as family members and key employees, in the event of an owner’s death, incapacity, or other life change.
An Updated Will and Other Estate Planning Documents Are a Good Place to Start
First, an updated will and other estate planning documents are a good place to start. In addition to a will, a revocable living trust agreement, durable power of attorney tailored for the business, and a letter of intent may be helpful.
Everyone should have a will. If an owner has one and it is several years old, he should consider reviewing it with an attorney. In a will, the owner could pass the ownership interest in the business to an individual beneficiary(ies) or to a trust created by his will (a “testamentary trust”). However, there is no guarantee that every stakeholder in the business will recognize the new owner(s) automatically by virtue of the will at the time of his death. Some financial institutions, for example, may require a court order stating that the will is valid before recognizing the authority of a beneficiary or executor to act on behalf of the estate or the business. It can take months for an executor or other interested party to apply to a court to probate the will, and for a court to order that the will be admitted to probate. It could take longer if there is any dispute about the will’s validity.
An owner should consider establishing a revocable living trust and transferring his ownership interest in the business to the trust during his life. The owner could be designated in the trust agreement as the trustee, and a successor trustee could be designated as well. As trustee, the owner could control and administer the ownership interest. In the event of death or incapacity, a successor trustee could control and administer it. The successor trustee could succeed automatically—without the need to probate the will.
A durable power of attorney is important. This power-of-attorney document grants a particular person the power to take financial actions for the owner in the event of incapacity. Is the business a sole proprietorship, or is it a corporation, limited liability company, or other corporate entity? If it is a sole proprietorship where everything is in the owner’s name, individually, a durable power of attorney may be sufficient. If it is a corporate entity, (1) a durable power of attorney supplemented to list specific powers that the agent would need to have to run the business in the event of incapacity may be needed; (2) a corporate resolution may be needed; and/or (3) an amendment to the company’s operating agreement may be needed as well.
A letter of intent for the owner’s beneficiaries or trustee—though non-binding—may help explain the estate plan and guide next steps. A letter could be kept with estate planning documents or provided to the trustee.
Plan for the Transfer of the Ownership Interest
Second, plan for the transfer of the ownership interest. If the company is incorporated, it should have a written operating agreement (e.g., bylaws for a corporation or a company agreement for a limited liability company). The operating agreement can include (or be amended to include) buy-sell provisions, and it should be accompanied by a spousal consent, if applicable. The provisions would help reduce uncertainty and the potential for conflict.
The provisions can specify who can become an owner and what will occur in the event of death or incapacity. The owner may want to give one or more family members or a family trust a right of first refusal to purchase his ownership interest. The buy-sell provisions may identify a back-up plan if a right of first refusal is not exercised (e.g., company buy-back, sale to a third party, or dissolution). The provisions can establish one or more valuation methods (such as a previously agreed value or hiring an independent appraiser) and describe whether the transfer would be a gift or a purchase. If the transfer would be a purchase, the owner or the company may want to obtain a life insurance policy which would provide proceeds in the event of his death. A potential purchaser(s) could also have the option to make installment payments under certain terms.
Train Successors and Compile Emergency Operating Instructions
Third, train successors and compile emergency operating instructions. If the owner is not available to work suddenly, what must be done to keep the company running? Owners should consider acting now to identify and train multiple people—family members, key employees, or others—to run the business.
Essential tasks—such as payroll, invoicing, and customer service—should be identified, and any necessary cross-training should be done. A calendar of recurring obligations may be a good resource as well. A communication plan, particularly in the event of an emergency, should be outlined. The location of account information, passwords, key vendor and customer agreements, leases, business licenses, insurance policies, tax returns, and employment records should be clarified. Emergency cash reserves or a business line of credit should be available. Contact information for advisers such as lawyers, accountants, bankers, payroll providers, and insurance brokers should be listed. Documents showing that successors are authorized to run the business in your absence—such as an operating agreement, company resolutions, and durable power of attorney—should be accessible.
Consider Key Employee Agreements
Fourth, consider key employee agreements. Owners may wish to enter into certain agreements with key employees. In the event of an emergency or other transition, it may be crucial for key employees to stay with the company or not walk away with the business if they leave.
A key employee retention agreement could incentivize them to stay. The agreement could specify, for example, that a particular bonus will be paid to the employee if he stays for a certain length of time and meets certain performance targets. It could provide equity or stock option incentives. The agreement also could provide for what happens to the employee’s position and compensation in the event of certain company events, such as a sale.
An agreement with a key employee regarding non-disclosure, non-competition, and/or non-solicitation requirements can help protect the company if the employee leaves. Non-disclosure provisions would define “confidential information” and specify legal actions that the company could take in the event of a breach. Non-competition provisions could limit the employee’s ability to work for a direct competitor for a specified time within a particular geographic region. Non-solicitation provisions would prohibit a key employee from soliciting the company’s clients or other employees.
In conclusion, there is no time like the present for owners to conduct estate planning for their businesses. Brainstorming about the future of the business and documenting next steps could help owners make day-to-day decisions more readily and with added peace of mind. These actions also could help owners’ family members and key employees to better anticipate and prepare for the future.
Teresa Schiller practices law at Teresa Schiller Law PLLC and is of counsel to Lighthouse Legal Services, PLLC, which has multiple offices in Texas. Her practice involves business, estate planning, probate, employment, and real estate law matters. Schiller can be reached at teresa@teresaschillerlaw.com or teresa@llslaw.com.