Do you have a partner? Do you have a plan if your partner dies, is disabled or wants to leave the business? You should. If you don’t, you risk all of the hard work you put in to build your business into what it is today. Expensive, time consuming and unpredictable litigation between the business and the estate of your partner, or among the beneficiaries of his estate can result, and a company can be forced to sell its assets and close up shop.
What should happen if your partner passes away? Do you want his wife of children to own his part of the business? That means you will be spending a significant portion of your time working to support them instead of your own family.
What should happen if your partner wants to sell the business but you don't? Should he be able to pick a new partner for you?
What should happen if your partner can't work in the business any more? What if he simply doesn't want to?
Under most of those circumstances, you will want to purchase the part of the business owned by your partner.
At what price? How do you come to an agreement with a grieving widow or children (who might even not be of legal age yet) over the value of your late partner’s share of the business? Remember, this is the company that was the source of all good things for your partner’s wife and kids. They probably think it’s worth much more than you do (or your partner did), because you know that owning your particular business is really just an opportunity to work very hard and reap the rewards of that hard work. Even worse, if you and your partner disagree so strongly that you want to go your separate ways, how do you come to an agreement on the price to be paid with someone with whom, by definition, you are already arguing?
Should you have to pay the purchase price out in cash all at once? Is that possible? What resources are available to the business to raise that kind of cash? Will you have to sell the business to satisfy the demands of your late partner’s widow?
What should happen when your partner passes away and his estate has to file an estate tax return. The taxing authorities will want to verify the value shown for the business on that return. Reams of financial data can be demanded from the business for the purpose of giving it to the taxing authorities. Is that acceptable to you?
What should happen if you want to sell your share of the business and your partner does not? And what happens when your partner has not passed away but is no longer able to work in the business? You need an agreement about what happens when your partner wants to sell the business but you do not. You need an agreement about what happens when your partner can’t (or won’t) work in the business any more.
Now think about what should happen if YOU are the one who died or is disabled, what should happen when YOU want to sell but your partner does not, and what should happen when YOU can’t or won’t work in the business any more.
You need to a way to (a) make sure you do not have to agree on a price for the business after someone passes away; (b) eliminate the need for the late owner’s estate to pay for an appraisal of the business; (c) thereby make it unnecessary for the IRS to receive any financial data at all about the business for the purpose of determining its value; (d) provide a source of ready cash to use to pay for the deceased owner’s share of the business without significantly interfering with cash flow or increasing its value for estate tax purposes; (e) make sure that you and your partner work in the business for as long as both of you own part of it; and (f) provides a mechanism for a smooth exit if one of you leaves or becomes disabled. If that sounds like you should be looking for a prenuptial agreement for your business, it’s because you should be.
The good news is that there is a way plan how to do all of that. It is called a buy/sell agreement, and if it complies with the various income and estate tax rules it will make your life simpler, not more complicated by accomplishing all of the above and more. Unfortunately, you can’t learn much more about this kind of agreement without having a frank conversation with both your partner and your family. Ideally, the buy/sell agreement should be one piece in a comprehensive estate plan for both you and your partner that deals with your respective ownership interests in the business, estate taxes, administrative expenses and providing for your families in a manner that maximizes the benefits realized and minimizes the risks incurred by the family.
It can be done. It is not rocket science, but that does not mean that there is a simple solution to the problems that need to be resolved. You, your family and your partner and his family all need to speak with a lawyer familiar with those income and estate tax rules. Maybe more than one lawyer. It would be much better if that discussion took place while everyone was still alive and healthy. It would be better still if that discussion took place while everyone is still actually speaking to each other.