Future plan key for business owners

Every business owner will leave his business eventually, either through retirement, death or a buy-out.

Still, establishing a plan for the future is a daunting task many business owners would rather not tackle. But for those who do, it can mean the difference between financial life and death for the business owner, his family and the company.

The estate planning needs of the business owner go above and beyond death to include business succession issues that have potentially lifelong consequences for the entrepreneur and his survivors.

While sole proprietors, family-owned businesses and multiperson partnerships pose slightly different challenges, experts say business succession planning is a topic that every business owner should face -- and soon -- despite the bad taste it can leave in your mouth.

"People get very emotional during the estate planning process," said Briggs Matsko, a senior financial planner and executive vice president in the Sacramento office of Lincoln Financial Advisors Corp. "Partnerships are almost like marriages. Most people don't want to rock the boat."

But Matsko said it is far better to go ahead and turn the boat upside down if that's what it takes to ensure the best possible outcome in the event of a partner's death, incapacitation or retirement.

Matsko said he tries to inject a dose of reality with his clients by asking questions such as, "If your partner dies, then do you want to be in business with his wife or children?" He follows that with, "How would you buy out your partner's spouse if he died tomorrow? Would you be forced to sell the business or work with a new partner you can't stand? What if your children don't want to take over your business? How will your family pay estate taxes in the event of your death?"

Because the questions and scenarios are virtually endless, business succession planning is critical to ensuring that business owners and their families aren't burdened with difficult decisions during a time of grief, potential lawsuits for years after the fact, and bad blood between good friends down the road.

Family unfriendly: Family-owned businesses are perhaps the most vulnerable, said Trudy Nearn, founder of Generations, a Sacramento law firm that specializes in business succession planning, because a large portion of the estate is typically tied up in the business.

Nearn recalls a client with three children who divided his business up into three equal parts in his will.

The problem arose because only one child was working in the business. The eldest son worked day and night to keep the business afloat while his siblings watched on the sidelines and collected two-thirds of the profits.

"Eventually he got so angry that he sold everything, distributed the money and went along his way," Nearn said. "So the business was lost because the distribution method forced him to be a slave to his siblings. That's probably not what the father anticipated."

With unrelated business partners, the situation is quite different. In this scenario, experts recommend drafting a "buy-sell agreement" to assure the orderly transfer of interests. Buy-sell agreements define the terms and conditions of a future sale of the partners' interests in the event of a death, disability, retirement or other circumstance.

"Buy-sell agreements restrict who can be a partner in the business," said Timothy Murphy, principal of Estate Planning Counselors of Northern California Inc. in Sacramento. "Without an agreement, one of the partners' spouses could come in and pollute the office environment and risk the integrity of the business."

Death, taxes and insurance: Tax planning goes hand in hand with business succession planning, because if the Internal Revenue Service forces a sale of the business to pay estate taxes then succession is no longer an issue.

"The IRS has to be paid in full within nine months," Nearn said. "Some people think they can pay the taxes with life insurance proceeds, but life insurance is also subject to estate tax. Only a life insurance trust allows your survivors to use 100 percent of the proceeds to pay estate taxes."

Matsko of Lincoln Financial recommends business partners take out life insurance policies on one another so that in the event of a death, the surviving partner can buy out the deceased's family.

Although insurance can drain some cash flow out of the business to pay premiums in the short term, it can save millions in the long term.

"Insurance is a great way to leverage dollars," Matsko said. "You can have a dollar for three cents and avoid liquidating business assets if a partner dies."

Selling the farm: Of course, death is not the only exit strategy. Some business owners choose to sell the business and retire while they can still enjoy the fruits of their labors.