Most of us are aware that there will be financial consequences if we lose our husband or wife and understand that this event is likely to create some financial stress. Many people have some sort of strategy to mitigate the financial risk, whether it is through life insurance or building sufficient assets to fund our lifestyle.
The financial consequence of losing a business partner can be just as dire and far more complicated. Unfortunately, most people who have business partners don’t address this risk at all.
The first issue that needs to be considered is what happens to the business in the event of a partner dying? Do you want the spouse (or beneficiary) to become an owner? Do you want the surviving parties to buy out the estate? How do you determine the value? How do you fund it?
It is best to discuss and document all of these things in advance in a partnership agreement (depending on your business structure, it may also be referred to as a shareholder or unit holder’s agreement).
Most people think of these documents mainly as a means to resolve disputes, however, this is only a fraction of the benefit a partnership agreement covers. They also cover how to bring in new partners, plans to exit the business and, in the area I’d like to address here, succession planning in the event of the death of a partner.
Depending on the type and size of the business, it can be quite common for a large portion of an individual’s wealth to be in their business, this is certainly the case for me. Obviously, most people would like that value to go to their own family, not their business partner.
This creates a problem for the surviving business partner, not only have they lost the attributes that their partner contributed to the business, they now have to find a way to buy out the estate of the deceased partner or come to some other arrangement. Again, if this isn’t discussed beforehand, after the event, establishing the value of the business or the terms of the agreement are now adversarial in nature.
Funding the purchase in many cases will be difficult.
Unless the surviving partner has the funds available, they will need to make other arrangements such as obtaining a loan. This may place cashflow pressures on the business.
One very effective strategy to deal with this in advance is to use a buy/sell contract outlining the terms of the sale. It is also advisable to obtain an insurance policy on all business owners to fund the purchase.
This results in the surviving partners being able to continue to own the business, and the estate of the deceased is able to receive their share of the value of the business.
If you’re in business with other people, I’d highly recommend going through the process of developing a partnership agreement and addressing what happens if one of the partners dies.