Business owners often plan ahead for items like improving future profitability and growth.
By Dean Hedeker
However, what many fail to plan for is the unexpected demise of…themselves.
The frequency of natural disasters over the past few years – with many more on the horizon, thanks to climate change – is a stark reminder that the unexpected can happen anytime to anyone, and is an important reminder to small business owners to plan ahead to mitigate risks and secure assets in order to properly protect the business.
The Risks are Real – and More than Many Realize!
Many small business owners have invested a significant amount of time and money into their business to make them successful. However, all of that hard work and sacrifice could be wasted if the business isn’t properly protected against myriad risks.
For instance, a common but not very well known cause of business failure is the necessity of paying federal gift and estate taxes upon an owner’s death. When an owner dies, all of the business assets are subject to taxation because they remain part of his/her estate. Too often, assets necessary to the survival of the business must be liquidated just to cover the tax bill!
In addition to a tax bill, the list of potential threats to a small business is likely much longer than many business owners realize. Your business assets could also be at risk because of a wide range of threats, including:
- An owner’s personal divorce
- Business debts
- An owner’s incapacity
- Long-term care expenses
Knowing about these risks ahead of time will help with developing a comprehensive asset protection plan to ensure a smooth succession.
Asset Planning Strategies to Consider
To mitigate these risks, business owners need to plan ahead for various risk scenarios and develop strong asset protection strategies to insulate the business from potential issues that may arise due to an owner’s unexpected exit.
Begin with choosing the right legal business entity. There are four basic types – sole proprietorship, partnership, corporation or Limited Liability Company. Many default to a sole proprietorship, but as the business evolves this entity may no longer be the best fit, and it may make sense to switch to another type of business.
Other strategies to consider include:
- Enter into a Buy-Sell agreement, an agreement to sell the owner’s interest in the business to a specific party (or parties) at an agreed upon price, or using an agreed-upon method for determining the price, in the event anything happens to the owner that causes them not to be able to run the business.
- Transfer interest in the business slowly. A sudden transition for a business can leave employees feeling shell-shocked and confused. Instead, take a more measured, gradual approach. For instance, a Limited Liability Company (LLC) is a useful tool for transferring the business to the next generation while also providing some asset protection benefits, ensuring that the majority or all of the business assets are transferred to the next generation long before the death of an owner.
- Keep business and marital assets separate. This may seem obvious, but you’d be surprised at how many business owners don’t actually do this! Even if an owner resides in a state that recognizes separate property, that property can in fact become marital property, and therefore can be subject to division in a divorce if the property is co-mingled.
- Update your estate plan. Having the most up-to-date estate plan will help ensure that the owner’s family is being provided for in the event of the unexpected, as well as the business itself.
- Include incapacity planning in an estate plan. It’s not just an owner’s death that should be the motivation for planning ahead to protect business assets – there’s also the possibility of an owner becoming incapacitated due to illness or injury that can make him or her unable to perform their job. Consider implementing an incapacity plan to focus on ensuring that someone has been designated and has the legal authority to take over the business in the event of an owner’s incapacity.
- Plan ahead for long-term care. Along with planning for the unexpected, at some point many owners may need long-term healthcare, which can be cost-prohibitive. To avoid having business assets pay for that care, plan ahead by including Medicaid planning in an estate plan.
The future of many businesses and their owners may be unknown, but by planning ahead and having a solid asset protection plan in place, owners can rest easy knowing their business will be safeguarded in the case of the unexpected.
Dean Hedeker is owner and principal of Hedeker Wealth in Lincolnshire, Ill. He has more than 35 years of experience in estate and financial planning and wealth management. He is also an attorney at law and a Certified Public Accountant, and can be reached at firstname.lastname@example.org.