Plan ahead for smooth corporate succession

You’ve heard of a “C Corp,” an “S Corp,” a “Limited Liability” or “Professional” corporation. Regardless of type, all corporations share one basic characteristic: they all issue a percentage of ownership (stock). Because that stock can be inherited, a corporation must consider its plans for business succession.

Of primary interest to most MRA members are corporations that are partly or wholly family-owned. Typically, they are closely held—that is, not publicly traded—and a single individual may own all of a corporation’s stock. Usually, though, the stock is split among several people or entities, either on an equal basis or with one stockholder maintaining a majority interest (51 percent or more) and one or more other stockholders holding minority interests.

Other types of businesses may terminate when the owner or a partner dies, leaving survivors to reorganize in order to continue the business. A corporation, on the other hand, continues to exist, with the stock passed on to new owners. Since stock in any corporation is generally considered an asset, it typically passes on to the heirs of the deceased.

This often creates a difficult situation within the family of the deceased, as well as between the family and the remaining stockholders. In cases where a principal stockholder with controlling interest dies without the benefit of proper planning, the deceased’s stock interests will pass to surviving family members by means of a will or in accordance with laws administered by the state in cases of death without a legal will.

Other surviving stockholders will retain their original percentage of ownership and will now be in business with the deceased’s heirs, who may or may not want to be involved in running the business. If the heirs maintain the controlling interest, they may try to force the minority stockholders to buy their stock at their asking price.

The heirs might also simply sell their controlling interest to a rival or outside concern. Or they could use their controlling interest to change the direction of the company or declare dividends so that they receive income.

Too often, none of these situations is good for the business. Small, closely held businesses are frequently run by family members or partners who respect each other’s position and responsibility within the business. Adding strangers to the mix too often marks the beginning of the end of a business.

Consider a different scenario. After a stockholder dies, the surviving minority shareholders join forces to constitute a majority ownership. They now control the direction and the profits of the company, which could leave the heirs of the deceased with a minority ownership. That could leave them with no control of the company’s direction and no income if the majority stockholders vote against declaring a dividend. This situation has resulted in many a family needing cash but left with only a portfolio of inherited stock that will bring nothing.

In both scenarios, someone loses. Either a family loses the security of a business interest they depend on for income, or partners who have worked hard for the company over the years are left with nothing. Either way, often someone loses income, stock loses value—in some cases, all involved lose their business interests.

How can your small corporation avoid such a situation? A corporate buy-sell agreement funded with a life insurance policy can be a solution for all stockholder parties.

When properly arranged, this agreement will require the heirs of the deceased to sell the inherited shares to the corporation or to the surviving stockholders. The deceased’s life insurance policy provides all of the funding for the agreement, so neither party loses.

Regardless of the percent of corporate shares they inherit, the insurance coverage helps ensure the heirs receive the cash equivalent to the value of those shares. A buy-sell agreement can achieve a fair and acceptable transfer of money for stock, especially for those heirs who are not involved in the day-to-day operation of the business.

The surviving stockholders benefit from a buy-sell agreement because their percentage of ownership will remain the same or increase. They can continue to guide the corporation in the direction that they choose. Control will remain with the stockholders and they will not suddenly be forced to run a business with the unschooled or unprepared.

A buy-sell agreement can also help prevent diminished earnings or a drain on the corporate coffers, which is particularly important because the death of one majority stockholder can cause a period of financial loss that should not be compounded by an additional burden on corporate profits.

The life insurance policy is key to the success of a buy-sell agreement. It can provide all of the funds needed and deliver them at the proper time.

For more information on a buy-sell agreement or the arrangement that is most appropriate for your business, consult your financial planner, attorney, tax consultant or life insurance agent. MRA offers life insurance at competitive rates. AAA Michigan and its agents do not provide legal or tax advice.