How Does Estate Planning Differ from Business Succession Planning?

Estate planning and business succession planning are not the same thing. Succession planning is aimed at sustainability and relates directly to the business itself. It is a strategy crafted to enable smooth, effective operations as the business passes to future generations or successor owners. On the other hand, estate planning pertains to all assets in an individual’s estate, including any business interests. However, estate planning can play a vital role in business succession planning.

Why Is Business Succession Planning Important?

It is common for business owners to spend countless hours, days, or years building a business from the ground up. It makes sense to create a succession plan to help ensure the company continues running smoothly, with no decrease in value, in case an owner becomes disabled or passes away or when an owner retires. Careful planning can help protect a business from tax liabilities and other threats. Common goals of succession planning include:

  • Allowing for a smooth transition in management
  • Arranging to reward children who work in the family business or compensate children who do not
  • Providing sufficient income for the retirement of a business owner
  • Ensuring a fair price for ownership interests when it is time to retire
  • Ensuring surviving family members receive a fair price for business interests should an owner die unexpectedly

What Is Involved in Business Succession Planning?

A well-crafted succession plan specifies how assets, ownership, and responsibilities will be divided, identifies who will step into key roles, and outlines how the business will operate in the event of an owner’s disability or death. Planning should consider business processes, family involvement, and tax consequences. Business succession planning may involve:

  • A review of the current state of the business
  • Estate planning for the business owner
  • Obtaining a valuation of the business
  • Establishing personal and corporate goals
  • Contingency planning
  • Wealth management
  • Developing an exit strategy
  • Execution of a sale
  • Training, development, and support of successors

What Role Does Estate Planning Play in Business Succession?

Estate planning is an umbrella approach that includes but is not limited to business succession planning. If ownership interest in a business forms part of your estate, you may want to divide that interest among your heirs separately from personal property and financial assets. This may involve distributing stock among your beneficiaries or designating certain family members to take over key business operation roles. The following are some possible scenarios for estate and succession planning:

  • Heirs manage the business: When the business owner dies, his or her ownership interest in the business passes to heirs through a will or a trust. The heirs are able to step in to manage the business and keep it operating smoothly.
  • Heirs sell their business interests to a new owner: Business ownership interest passes to heirs through an estate plan. The heirs sell their inherited interests in the business to a new owner.
  • Heirs retain their interest in the business while co-owners manage it: A deceased partner’s ownership interest in a business is passed to their heirs through a will or a trust. While surviving co-owners continue to manage the business, the deceased partner’s heirs receive profit distributions as they are paid out.
  • Surviving co-owners of a business buy out the heirs: When one business owner dies, their interest in the business passes to heirs through an estate plan. Surviving co-owners of the business buy the ownership interests from the heirs, typically through a previously arranged buy-sell agreement. (See Cornell Law School, Legal Information Institute (LII) definition. Life insurance plans are often established to fund such agreements.

What Estate Planning Tools Can Be Used in Business Succession Planning?

For many small businesses, any period of disability, let alone the unexpected death of an owner, could be disastrous. It is essential to plan for the unexpected, using estate planning tools including the following:

Business Power of Attorney: This document designates an agent to act on one’s behalf to manage financial affairs should a person become incapacitated through illness or injury. A business owner may appoint a trusted individual to transact business and make financial decisions on their behalf. With a Power of Attorney, the designated person, known as the “Attorney in Fact,” is granted the authority to make banking decisions and handle real estate and other transactions in the place of the business owner. It is possible to have two Powers of Attorney – one for personal affairs and the other for business matters. A power of attorney may always be effective, or it may become effective only under certain circumstances, for example, if the business owner becomes incapacitated and incapable of making decisions.

Will: A last will and testament is a document that provides instructions on how assets are to be distributed among beneficiaries after a person’s death. It must be drafted in accordance with Arizona Revised Statutes, Title 14 – Trusts, Estates, and Protected Proceedings. A business owner’s will should specify how business interests should be handled. It should state whether and how these assets should be sold and distributed among beneficiaries. If the business is to continue, the will should specify who will take over management in the owner’s place in conjunction with a buy-sell or operating agreement. A will can be used to establish a Testamentary Trust to ensure business assets are held, managed, and distributed according to the deceased owner’s wishes.

Trust: A trust is an even more powerful instrument than a will. If properly drafted, a trust can provide far deeper levels of control over how a business is inherited and managed after the death of an owner. A trust is the gold-standard form of estate planning, and its flexibility is particularly powerful when dealing with the complexities of business succession.

Insurance: Many forms of insurance are particularly helpful in business succession planning. Key person insurance, first-to-die policies, and insurance to fund a buy-sell agreement are especially valuable tools. We are one of the few estate planning firms who are qualified to include insurance as part of a well-designed estate plan.

The importance of seeking experienced legal counsel in business succession planning cannot be overstated. Contact Israel & Gerity at 800-659-7575. We provide skilled legal representation in both estate planning and business law.