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An owner-operated business often will not survive the death of the business owner. Only the “fully grown” business, in which all key positions are filled by personnel other than the owner, is clearly set to withstand the impact of losing the owner-operator.
Most owner-operated businesses are not operated in that manner, with key positions filled by employees. Even if the business IS intended to be structured that way, many owner-operated businesses cannot reach the size and sophistication level to pay (or attract) the necessary key employees. And even more often, that is not the plan. Often, the whole point of having your own business is to do what you enjoy doing – being the key person, doing far too many of the different jobs required of management. Many owner-operated businesses make a very good income for the business owner specifically because the business owner is effectively handling two or three different jobs in the company.
Where there is only one owner, the only choices after the owner’s death are sale of the business to a third party, or having the business operated by one or more heirs. If neither course of action is possible, the value of the business becomes the liquidation value (desks, chairs, inventory, etc.), even if the ongoing business was very profitable or had a high valuation.
A business owner may know a number of potential buyer for his or her business – customers, suppliers, or competitors. Does the spouse or child who would try to sell the business in the event of the owner’s death have any idea who these potential buyer’s are?
A business owner may be aware of difficulties in the business (personnel, financial limitiations, competition, etc.) that make operation of the business by a spouse or heirs very difficult, inadvisable, or impossible. Does the spouse or executor of the estate know this?
The business owner’s plan should address this issue of whether the business can survive the death of the owner.
Alternatives
If you are the owner of a business, and your business has not yet (or never will) reach the point where all key positions are filled by others, you need to have an idea of whether your business can survive you and what should be done in the event of your death.
(1) Is this a business that should be sold immediately in the event of your death? If so, you must tell your spouse – and the executor of your estate - not only that the business must be sold, but what the value is, what key aspect of the business is of value, and who are potential buyers of the business.
(2) If the business should be sold in the event of your death, have a plan to give your spouse (and executor), on how to go about selling the business. Tell your spouse very specifically what you think should be done. Make sure your spouse knows the contacts (a business friend that would handle business negotiations, business attorney, your accountant, etc.) Your spouse may have no idea who you use as advisors and what to ask of them unless you give specific instruction.
(3) If you don’t know whether or not your spouse or children could run your business in the event of your death, do some calculations now to see if you believe they could do it. They need YOUR expertise in determining if they have what it takes. If you don’t figure it out and let them know before something happens to you, they may have to learn the hard way that they cannot run your business without you. Furthermore, your spouse or children could spend so much money trying to operate the business that you will have left them a “negative inheritance.”
(4) Calculate how many different jobs you perform and how many people would be required to do your “jobs.” Determine what would have to be paid in salary or outside services to have all the jobs adequately filled. Now calculate whether the business would be viable if gross revenue remained the same and all those jobs were filled by people who must be paid. Calculate whether the business would still be profitable if gross revenues were to drop after your death. Isn’t it likely that the gross revenues would drop drastically? Are you the key sales person? Are you the key provider of services? Are you the key contact for your customers? If any of these are your situation, you should anticipate a serious drop in gross revenues. For some businesses, the drop would be 100%.
(5) Determine whether the business could continue to pay your spouse the amount of your salary, if your spouse were to try to operate the business after your death. By paying other people to do bookkeeping, payroll, contracts, estimating, sales, and whatever else you currently do, could your spouse keep the business going? What role could your spouse play? Does your spouse have people management skills? Financial management skills? Would there be any money available to pay your spouse after paying all the other new employees?
(6) Determine whether your spouse could live on a much lower income in the event of your death. If the business would not generate the level of income needed in the event of your death, your spouse must know that the business must be sold (and you should also look at purchasing life insurance to fill the gap).
(7) Tell your spouse (or kids) about the difficulties of the business. Many people who do not operate businesses (including the spouses of business owners) have no idea how difficult it is to run a profitable business – especially a small business, which does not have the economies of scale to cover mistakes, misteps, and unanticipated expenses. Some spouses may have the idea that if they showed up at the business from 8:00 to 5:00 the business would magically generate an income for him or her.
(8) Talk to your estate planning attorney and make sure your designation of an executor of your estate, and plans for payment of taxes are consistent with your “ultimate exit” plan for your business. If you believe your business should be sold immediately, your estate planner should know this. More importantly, if you expect your spouse or heirs to operate the business after your death, it is very important that your estate planner know this. There are tax consequences from any sale or liquidation of a business, and there may be estate taxes that would be difficult to pay without the sale of the business.
(9) Make sure your “ultimate exit” plan is consistent with your overall business plan.
If the business must be sold very quickly in the event of your death, your business plan must include keeping the business in saleable condition.
If it seems that your spouse and/or children could operate the business under some circumstances, then include those circumstances in your business structure. For example, have your business plan include more delegation of administrative activities (bookkeeping, accounting, billing, purchasing), and more hiring of additional sales people or managerial people than you would if you were not considering the issue of your death. Obviously, this may be a big modification of the business plan, with not insubstantial cost. But the objective would be to have a more complete business structure that could operate with the least disruption in the event of your death.
In addition, if you think your spouse or children would or should run the business in the event of your death, make sure they have two types of knowledge of the business: some background and experience in working at the business (the day-to-day operations); and also, just as important, current information on the personnel, competition, financial challenges, or whatever is going on in the business and the industry. Someone who steps into the business must be prepared with knowledge of the current problems and opportunities.
If the spouse or heir expected to run the business would be seriously out of step with the business or the industry, the plan has to be reconsidered. The whole point of a plan is to try to make all aspects of structure, preparation, and implementation consistent with one another.
You must realize that you know ALL of these things better than anyone on the face of the earth. Do not leave it to your loved ones to go through the trial and error of trying to sell your business or run your business without any help from you.
If ill-advised family members attempt to run the business and cannot, will they take out loans in an ill-fated attempt to run the business – only to sell at a loss with debt on top of it, after some period of time? The last thing you want is for your family to go broke trying to “save” a business that cannot be “saved” without you.
It is a rare situation that the spouse or children are capable of operating the business. Business is too difficult today. Profit margins are tight. A successful owner-operated business is often successful based on a unique position in the industry, tight financial management that compensates for low margins, and efficient operation with some individuals (including the owner) performing a number of key functions in the business.
Filling the positions that need to be filled after the death of the owner changes the culture, the contacts, the efficiency, and the profit margins.
Have a plan! Only you can design the plan that works best in the event of your death.
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If a business has two or more owners, the surviving owner(s) will want to purchase the ownership interest of a deceased co-owner, and the estate of the deceased owner should be pleased to have a market for the business interest.
A buyout agreement signed in advance provides a commitment of the surviving co-owners to purchase and a commitment of the estate of a deceased co-owner to sell the ownership interest. But valuation can be a real problem. The loss of one owner often is a serious financial blow to the business, and the business value can drop significantly, even where one owner remains to operate the business.
Where each owner has his or her own clientele or area of expertise, it is possible for the value related to the deceased owner’s business and area of expertise to drop drastically. The surviving owner will want to buy out the deceased owner’s stock, but the value of the business after the death of a co-owner may really be just the value of the surviving co-owner’s part of the business. It can be difficult to come to an agreement on purchase price or method of valuation in a buyout agreement, when the business will still have value after the death of a co-owner, but not from the deceased owner’s part of the business operations.
