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Estate Planning for Small Business Owners in 8 Steps

Priyanka Prakash

Senior Staff Writer at Fundera
Priyanka is a senior staff writer at Fundera, reporting on business financing, law, and news. Previously managing editor at Fit Small Business, she's also a licensed attorney who served as general counsel at a Y Combinator tech startup. She loves helping entrepreneurs launch, run, and grow their businesses.

As a small business owner, you have dozens of things competing for your attention on a daily basis. Marketing your product or service, hiring staff, invoicing customers… the list goes on. Most business owners are too busy taking care of the here and now to think about the future. In fact, 30% of business owners have no estate plan, and many of those who do haven’t updated their estate plan recently.

Business estate planning helps ensure that your business matters are handled according to your wishes when you die or if you become disabled. This is not a subject most people want to think about, but good planning will protect the business that you’ve worked so hard on and poured so many resources into. This is true for all businesses but especially for family-owned businesses that you want to pass down to the next generation.

Estate planning for small business owners involves a long, detailed discussion with a lawyer and financial advisor who are experienced in estate and succession planning. But there are some things that you can start thinking about now to inform your discussion. Here’s what you need to know to put together a comprehensive business estate plan.

Why Business Estate Planning Is Important

Most small business owners who don’t have an estate plan didn’t bother to create one because the topic is too difficult to think about. No entrepreneur wants to imagine a time when they cannot take an active role in their business.

But proper business estate planning accomplishes two things. It ensures that someone you trust takes over your business when you can no longer be present, doing right by your customers. And, since your wishes are contained in writing, a good estate plan also simplifies things for your loved ones if you pass away prematurely or become disabled.

Small business owners, such as Jonathan Rosenfeld, owner of a personal injury law firm, get peace of mind from creating an estate plan:

“As the owner of a small law firm in Chicago, I now have an estate plan to provide some continuity of services in the event of my untimely passing (which I hope is not imminent). My family and my staff are aware of the plan should I become incapacitated or die. They not only know how to access client files, but they also know how to contact several other attorneys that I regularly work with to help transition the cases to them.

While there’s definitely an uncomfortable part of the discussion and the sense of the inevitable, I strongly feel that as a professional, I owe this duty to my clients. In addition to my clients, I also want to make sure my family and friends don’t have to struggle with this firm, as it is an operational entity, if I can’t lead the way.”

As an entrepreneur, you have a business that probably accounts for a large portion of your net worth, so it’s important to plan how your company will be handled in the event of your death or disability. Without proper estate planning, the business you’ve worked so hard to build could be in jeopardy.

estate planning for small business owners

The 8 Steps of Estate Planning for Small Business Owners

Estate planning for small businesses is a long, detailed process. There are multiple questions to answer, scenarios to think about, and hypotheticals to address. For this reason, you shouldn’t attempt to put together an estate plan on your own. One missed issue can result in years of litigation if you die or become incapacitated. It’s vital to get the advice of a lawyer and financial professional who you trust and who have significant experience in business estate planning.

John Goodhue, a lawyer and owner of financial advisory firm Asset Protect One, says that estate planning for entrepreneurs goes beyond just creating a will. “Entrepreneurs should engage in full spectrum planning for the future. That starts with traditional estate planning, such as creating a will, but also includes things like tax efficiency planning, planning for a disability, and succession planning to prepare future owners for a transition.”

Here are the basic steps of estate planning for small business owners:

Step 1: Start With a Will and Basic Estate Plan

The following basic documents should form the core of your business estate plan:

  • A will that states your wishes about how your business and other property should be divided upon your death.
  • A power of attorney, which appoints another individual to manage your finances and undertake business transactions in the event you’re incapacitated.
  • A healthcare directive, which appoints another individual to make medical decisions for you if you cannot do so for yourself.

Without a will, your business will be divided up according to the default laws in your state. A will, power of attorney, and healthcare directive ensure that someone you trust inherits business property and manages business transactions on your behalf.

Beyond these basic documents, there are deeper things to talk through with your lawyer and financial advisor. A basic will might not be sufficient for your needs, says Asset One’s Goodhue. For instance, let’s say you grant a power of attorney to your spouse to run the business if you’re disabled. In most states, your spouse won’t be able to use any of the business assets for their own benefit—to pay themselves a salary for instance—without petitioning the court for approval.

But by placing your assets into a trust and titling business assets in the trust’s name, you can make things much easier on your spouse. According to Goodhue, “An experienced lawyer and financial advisor will understand such details and can work with you to ensure that you don’t just have a plan. You have a plan that meets your expectations and will help your loved ones the most when they need it.”

Step 2: Plan for Tax Efficiencies

A big part of estate planning is tax planning. Tax laws are constantly in flux, so this is an ongoing discussion you should have with your lawyer and financial advisor.

The federal government levies an estate tax, which must come out of your estate before your beneficiaries receive their inheritance. Currently, the 40% federal estate tax only applies to estates that are valued at more than $11.18 million. That leaves most small businesses in the clear.

But states also charge their own estate and inheritance taxes. Inheritance taxes are a little different from estate taxes because they don’t just come out of the estate. The people who inherit the business have to directly pay the taxes.

There are ways you can minimize estate/inheritance taxes with good estate planning. For example, dividing up your estate into multiple trusts or creating a family limited partnership allows you to reduce your tax burden. An experienced estate planning attorney should be able to assist you further with this.

Even if inheritance and estate taxes aren’t an issue for you, other tax considerations are still at play. For example, a good chunk of your assets might currently be in a 401(k), IRA, or other retirement account. Those assets will flow to your beneficiaries upon your death and will be taxed on withdrawal later. Your attorney or financial advisor can discuss specific ways to tap into retirement money for business without tax penalties.

Step 3: Sort out Issues in Family-Owned Businesses

Family-owned businesses can face particularly prickly estate planning issues. It’s not uncommon, for instance, for there to be a situation where one child of a business owner is interested in taking over the business and the other isn’t.

Your estate planning attorney and financial advisor should be able to help you address issues like these in your estate planning documents. For example, one solution, says Goodhue, is to grant all of the business assets over to one child and the remaining assets to the other. That way, you can still be “fair” but avoid future inter-sibling fights that could put your company at risk.

Another common concern with family-owned businesses is to keep the business assets within the bloodline. Ordinarily, if a small business owner bequeaths business assets to their child, those assets will be jointly owned by the child and the child’s future spouse under marital property laws. Same goes if the business owner passes their assets to a spouse. Any future spouses of that person will jointly own in the assets. Fortunately, there are ways to keep the business in the family with careful estate planning.

Step 4. Draft a Buy-Sell Agreement (Optional)

If your small business has multiple owners, then a buy-sell agreement is an essential part of your estate plan. Buy-sell agreements specify who can buy an owner’s share of a business, under what conditions, and at what price.

A buy-sell agreement keeps a business in the hands of existing owners when one owner dies, becomes disabled, retires, or otherwise exits the business. Usually, the agreement grants existing owners first rights to buy the exiting owner’s share of the business according to a pre-set valuation formula. Those owners will buy out the exiting owner’s share either by directly paying the owner (if still alive) or the owner’s heirs.

The agreement might also set rules around when an exiting owner’s ex-spouse can lay claim to business assets as part of a divorce proceeding. Buy-sell agreements can be structured in multiple ways, so be sure to consult a lawyer to figure out which way is best for your company.

Step 5: Buy Life and Disability Insurance

Life insurance is a must-have for small business owners. Life insurance coverage provides your family or named beneficiary with a source of income when you die. In addition, life insurance can guarantee an income stream to the business to keep your company operating in your absence. Disability insurance provides similar coverage if you experience a short-term or long-term disability.

In most cases, business owners need to purchase two different types of life and disability policies:

  • A personal life and disability policy with your family as the beneficiary
  • A key person life and disability policy with the business as the beneficiary

Think of your family first, and make sure they’re well taken care of should you pass away or become disabled. Term life insurance provides coverage if death occurs within a specific time frame. Whole or permanent life insurance comes with an investment component and remains in place for your entire lifetime. Disability coverage can be purchased separately or added on as a rider to a life insurance policy. Your lawyer can help you figure out how much coverage to purchase, based on your age and health, your family’s lifestyle, and the age of any children in the household.

Key person insurance is similar to personal life insurance, but the beneficiary is the company instead of a family member. If the key person of the business, usually the business owner, passes away or becomes disabled, the company gets a payout equal to a multiple of the owner’s salary or the business’s profits. The remaining members of your business can utilize that money to pay employees, train staff, and keep the company afloat. Key person insurance can be a lifesaver for mom-and-pop shops, where the owners are critical to the business’s success.

Step 6: Create a Succession Plan

Creating a succession or continuity plan is where the lines blur between estate planning and succession planning. Your estate planning documents, such as your will, specify who is entitled to your estate upon your death or who should run your business if you’re disabled. Succession planning specifies how you, your family, and your company will prepare for a transition in ownership.

The focus of succession planning is keeping a viable business running, or preparing the business for sale, in your absence. A succession plan is a written document that starts off much like a business plan. It contains background information about your business, your target market, and your competitors.

It goes on to list the proposed organizational structure of the business in the event of a succession and what positions key personnel will assume in the event of your death or disability. You’ll also want to identify training opportunities or compensation adjustments for any of the key staff members. In the finances section of your succession plan, you’ll want to outline the financial state of the business, such as profits, assets, and the current valuation.

Remember to keep your succession plan document consistent with your will and other estate planning documents. This will prevent unnecessary and costly litigation down the line.

Step 7: Have a Discussion With Affected Parties

After you create your estate plan, make sure all the affected parties know what’s at stake. These are hard topics to talk about but ideally, you should consult your family members and friends throughout the process. This helps avoid conflict down the line. For instance, if you’re unsure about one of your children’s interest in the family business, you should find out for estate planning purposes.

Once the estate plan is in place, you and your family should sit down with your financial advisor and lawyer to make sure everyone understands what’s in the plan. This discussion doesn’t need to reveal specific assets of value or the size of the estate, particularly if you have young children.

According to Asset One’s Goodhue, “Just knowing that they’ll be receiving something of value down the line can change people’s priorities and the decisions they make during their lives.” Family members should also know how and where to locate your will, succession plan, and other estate planning documents.

Step 8: Update Your Estate Plan as Necessary

Once you have your estate plan in place, you’ll have to update it on a regular basis to make sure it reflects current laws and your current wishes for what you want to happen to your business.

Tax laws change regularly, both at the federal and state level, which can upend your current estate plan. Similarly, life events, such as a divorce, a child’s marriage, or the birth of a child or grandchild, can all affect your estate planning efforts. Having a business attorney who intimately understands your business’s needs can help you keep up with transitions over the years.

estate planning for small business owners

Don’t Delay Estate Planning for Your Small Business: Find a Good Lawyer, and Get a Plan in Place Now

Estate planning is important for everyone, but especially for small business owners. Your company is one of your biggest assets and something that you’ve worked very hard on. Business estate planning lets you ensure that your company continues as a successful, thriving venture. It starts with creating a will, but estate planning for business owners is more complicated than that.

There are tax, insurance, and family issues to think through and discuss with your lawyer to ensure that you, your loved ones, and your business will be well taken care of now and in the future.

Editorial Note: Any opinions, analyses, reviews or recommendations expressed in this article are those of the author’s alone, and have not been reviewed, approved, or otherwise endorsed by any of these entities.

Priyanka Prakash

Senior Staff Writer at Fundera
Priyanka is a senior staff writer at Fundera, reporting on business financing, law, and news. Previously managing editor at Fit Small Business, she's also a licensed attorney who served as general counsel at a Y Combinator tech startup. She loves helping entrepreneurs launch, run, and grow their businesses.

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