Business Succession of a Professional Corporation Using Life Insurance
If no estate plan or agreement is made in advance, Law firms and other professionally licensed incorporated practices (doctors, accountants, dentists) upon death of a owner-employee will see the shares of the corporation pass to the deceased estate for a brief duration
A integral part of estate and succession planning work with businesses involves the use of a team. At a minimum, that team should consist of a CPA and a Estate planning attorney. But what happens when a member of the team has the same needs as a client and needs to plan for succession of their own practice?
In a professionally licensed state-regulated practice shares of ownership can not pass to unlicensed heirs. The estate of the deceased is however entitled to receive consideration for the deceased's business interest. They can force this if not (C) incorporated by demanding liquidation of the portion of interest from the business or if incorporated, state law would see that another licensed professional pay for the shares (usually the surviving owners) or the entity buy-back the shares itself. Below is a description of the likely business structures and scenarios these types of professions would be in.
Why do Professional Corporations or PSC's need succession planning?
If no estate plan or buy-sell agreement is made in advance in law firms and other professionally licensed incorporated practices (doctors, accountants, dentists), death of a owner-employee will see the shares of the corporation pass to the deceased’s estate for a brief duration. The estate will not be allowed any say in the managing or operation of the business and is only assigned in absence of any will or estate planning giving direction of where shares are to go, and how they are to be paid for (buy-sell life insurance contract). The surviving partners may choose to purchase the deceased’s stock from the estate during this brief period or find another licensed qualified buyer. If neither is done, then the corporation itself must purchase the shares from the estate. Firms generally would like to avoid searching for the funds required to make these purchases through liquidation, debt, or scrambling to find a new partner during probate. As a result, life insurance is commonly used as the financial source the estate needs to execute a buy-sell or succession plan for either the surviving partners, qualified buyer, or corporation. This offers a tax free, fully funded, and pre-planned solution for the shares to be purchased from the estate. As the funding agreement to a binding succession plan, having this set up in advance also avoids costly probate for all parties.
Why do Limited Liability Companies or Limited Liability Partnerships need succession planning?
Many professional service partnerships may decide instead of incorporating to be treated as a LLC or LLP. If no estate plan or buy-sell agreement is made in advance, the estate has a claim to the liquidation of the part of the deceased's business interest to settle the estate. A written agreement can be made for the interest to be retained by the surviving owners after a pay out to the estate is made, forcing a re-organization of the partnership. The surviving partners can then vote to take on another partner who would then have to pay them for interest in the partnership.
The Buy-Sell Life Insurance Contract
The above are succession characteristics that only apply to professional partnerships in state regulated industries. In every other partnership whether incorporated (C,S, LLC) or unincorporated (general partnership, LLP, Sole proprietor) if not designated by a regulated license, the deceased owner's shares can pass to their heirs to become owners themselves or in the latter, face liquidation. In LLC, S-Corp or LLP, while no forced transaction or liquidation can occur unless voted on by the new owner's and all of ownership, this still leaves the issue of existing owners losing control of who has ownership authority in their business. In these cases the buy-sell contract life insurance would again be used to fund in advance the transfer of interest automatically to the existing owners or new owners away from the heirs. If no partner exists the need for the estate to have a buyer for the business at the ready is just as crucial. This allows the estate to be settled quickly and for heirs to receive immediate income from the business without liquidation or attempting to operate. In all business structures, the need for a buy-sell life insurance contract remains a business owner’s top priority.