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Business Succession Planning - The Foundation

by Alex J. Wolf and Clark R. Youngman, Attorneys, Koley Jessen P.C., L.L.O.

This is the second in a three part series of articles attempting to demystify business succession planning and its implementation. The first article provided a high-level overview of the succession planning process. This second article will outline some foundational aspects of succession planning, including information about the “basic” estate plan documents and other considerations. The third article will provide an overview of buy-sell arrangements.

Early on in the succession planning process, “downside planning” is typically performed to protect against the untimely death or disability of the business owner prior to implementation of a comprehensive succession plan. This planning typically consists of a basic estate plan and insurance planning, which together form a “foundation” upon which the other planning rests. In other words, estate planning and succession planning function in a mutually beneficial and interrelated manner for the business owner by contributing to the achievement of the business owner’s frequent overlapping twin aims: (i) ensuring the continuation of his or her business and (ii) providing for his or her family members (or other favored parties/charities) upon the business owner’s death.

Simply defined, estate planning involves planning for the thoughtful transition of management and ownership of assets (e.g., including equity in a business) upon a person’s incapacity or following death. Properly done, estate planning involves a comprehensive approach where the relevant parties work together to achieve the business owner’s personal and business goals and objectives. The basic estate planning process involves three primary components: (i) the estate planning documents themselves; (ii) the coordination of proper asset titling; and (iii) the implementation of appropriate beneficiary designations.

At Koley Jessen, we typically use four documents as part of the basic estate plan: (i) a Last Will and Testament; (ii) a Trust Agreement; (iii) a Durable Power of Attorney; and (iv) an Advance Directive. All of these documents can be amended or revoked at anytime during life while not incapacitated. Each document is described in more detail below.

Last Will and Testament. The Last Will and Testament is a document that controls the disposition of the “probate estate,” which includes all assets owned in the decedent’s individual name (i.e., as opposed to jointly with rights of survivorship) that are not subject to a beneficiary designation or a “pay on death” or “transfer on death” designation (i.e., a “POD” or “TOD” designation). In the majority of cases, the Will we prepare for clients provides that all assets of the probate estate simply “pour over” into the revocable Trust discussed below. In addition to disposing of the probate assets, the Will also allows for appointment of (i) a personal representative to handle the probate proceeding, if there is one, and (ii) guardians/conservators for any minor children.

Trust Agreement. The Trust Agreement is a document that establishes a revocable or “living” trust. A trust is a separate legal entity that is used to hold, manage and distribute assets for the benefit of specified persons. There are two primary reasons why we recommend using such a trust as part of a basic estate plan. First, a trust is an effective tool for the long-term management of assets in the event of incapacity. For example, in the event “Jane” becomes incapacitated, her assets could be transferred into her trust and the “trustee” identified in the Trust Agreement, as the legal owner of such assets, would manage the assets of the trust for her benefit. Second, a trust provides a means to avoid probate, by titling all individually-owned assets into the trust during life. The trust serves as the primary means of disposing of assets following death, identifying the beneficiaries and the manner in which they are to receive the assets (e.g., outright or in continuing trust managed for their benefit).

Durable Power of Attorney. The Durable Power of Attorney is a document by which an “agent” is appointed to manage financial and property affairs of the principal (i.e., person signing the Durable Power of Attorney). The Durable Power of Attorney typically provides that the agent’s authority to act only becomes effective if and when the principal becomes incapacitated. Because a trust is a more effective asset management tool during long term incapacity, the Durable Power of Attorney serves to “bridge the gap” by allowing the agent to transfer ownership of all individually owned assets to the trust in the event of the principal’s incapacity. The transfer of assets to the trust by the agent will not only facilitate management of the assets for the principal’s benefit during incapacity, but will also accomplish a probate avoidance objective.

Advance Directive. The Advance Directive is a combination of two separate but related documents – a living will and a health care power of attorney. The living will portion of the Advance Directive allows a person to express their intentions as to whether to withhold or withdraw “life-sustaining treatment” in the event they (i) lapse into a persistent vegetative state with no reasonable hope of recovery, or (ii) are diagnosed with a terminal condition that, without the administration of life-sustaining treatment, will quickly result in death. The health care power of attorney portion of the Advance Directive allows the person to appoint another individual as their “agent” to make health care decisions on their behalf (excluding end of life decisions) in the event they become unable to do so.

Business Management Committee. For business owners, the basic estate planning documents will commonly include provisions providing for the continued management of the business in the event of the incapacity or death of the owner. These provisions, which should be included in the Durable Power of Attorney, Trust Agreement and Will, typically involve the appointment of one or more individuals to serve as the “business management committee” to handle decisions related to the business. By appointing trusted family, friends, key employees or advisors who are familiar with the business to serve on this committee, the owner can ensure that the business continues to operate in an orderly, directed and hopefully skillful fashion following the unexpected incapacity or death of the owner. Moreover, if done right, the committee will be able to thoughtfully implement the next steps for the business, whether it be continued operation, sale or an orderly wind-down. Too often, without proper planning, a family is faced with the unenviable position of a “fire-sale” to prevent further loss of value or to pay expenses/taxes that might be due.

Asset Titling and Beneficiary Designations. As alluded to above, titling of assets and beneficiary designations play a key role in the overall estate plan and can actually “trump” a person’s estate planning documents. This is because assets passing by titling arrangement (e.g., assets titled as “joint tenants with rights of survivorship” pass outright to the surviving tenant by operation of law), or beneficiary designation (e.g., life insurance or retirement accounts pass to the designated beneficiary) will pass to the designated owner or beneficiary regardless of what the estate planning documents say. Thus, it is a critical component of estate planning to coordinate how assets are titled and beneficiary designations are made.

Insurance Planning. Liquidity in the event of the unanticipated death or incapacity of the owner should also be considered. The concern is that one of these events will occur and the deceased or incapacitated owner’s assets will consist entirely of the ownership interests in the particular entity. Such interests may be of significant value, but may be very illiquid, and thus are unable to help pay medical bills, taxes, etc. The business owner can hedge against such liquidity risk by obtaining one or more life insurance policies to provide for liquidity in the event of the owner’s untimely death, and disability insurance to help address in liquidity concerns during a period of disability and/or incapacity.

In sum, “basic” estate planning is not all that basic and, in fact, such planning forms the foundation for the overall succession planning effort and should not be overlooked or marginalized. Important issues to be addressed in the basic estate planning discussion include identifying fiduciaries (i.e., trustees, business management committee appointees, agents, etc.), the distributive scheme of the estate plan (i.e., who, what, when, and how), coordination of asset titling and beneficiary designations, and providing liquidity in the event of the unanticipated death or disability of the business owner.