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Estate Planning for Small Business Owners

Building a business is all about taking risk. You put your belief in yourself, your money, time, and more on the line to create something that can grow and succeed.

But whether your business will fund your retirement plan, or you hope to create a multi-generational family enterprise, there’s one area of risk you shouldn’t be taking.

If you own a business, you need an estate plan. And not just any plan. It needs to cover your wealth and safeguard your family. It also needs to ensure that the business can carry on or that there is an orderly plan for a sale or wind-down.

You’ll most likely need to consult with a financial advisor, a trust and estates attorney, and a tax accountant to get a comprehensive plan in place.

But here are five things to know about creating an estate plan as a business owner.

1. Start with the Foundational Documents

At a minimum, you’ll need a will, a power of attorney, and a healthcare directive, also called a healthcare power of attorney.

The will specifies the disposition of your assets; a power of attorney appoints someone to manage your finances if you are incapacitated, and the healthcare directive appoints someone to make healthcare decisions for you. These three documents ensure that someone you trust can run your business and make decisions.

Wills are a standard estate planning document, and there are some situations, such as appointing a guardian for minor or special needs children, where they are required.

2. Plan for Tax-Efficiency

The current federal estate tax exemption is $12.06 million. This may be above the valuation of your business, so you may not feel tax planning is necessary. However, the current exemption will “sunset” at the end of 2025 and revert to the 2018 level of $5 million, adjusted for inflation.

Estate planning is meant to be long-term and forward-looking. It’s impossible to predict what future tax laws may be with any accuracy, as they are tied to the political climate at both the state and the federal level.

It’s a good idea to build tax efficiency into your plan at every stage.

That may mean creating multiple trusts, managing a business 401(k) plan or cash balance plan, and planning how heirs will pay taxes on inherited property.

Inheriting a business without the means to pay the taxes due would cause an immediate cash crisis, at a minimum.

3. Plan for a Family Succession

If you intend for your children – or at least one of your children – to inherit the business, it’s best to have an unambiguous succession document in place.

Creating a mechanism for dividing ownership while preserving the decision-making powers of whoever will be the chief executive is critical.

You may also want to have documents that specifically keep the business limited to your children only.

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4. Create a Buy-Sell Agreement

If you have multiple partners and want to avoid disruption, it’s best to get a buy-sell agreement in place.

A buy-sell agreement grants existing owners the right to buy out the exiting owner’s share of the business using a pre-set valuation formula.

5. Life and Disability Insurance Can Protect Assets and Buy Time

Think about who the insured is. Do you need to protect your family or your business?

The correct answer is both, and you need separate policies for each of those beneficiaries. You’ll need a personal life insurance policy and disability policy with your family as the beneficiary to protect them.

To protect the business, you need life and disability policies on yourself and other key people, with the business named as the beneficiary.

The Bottom Line

There’s a lot more to a successful estate plan, but some of it is included in your day-to-day business planning.

For example, let’s assume the intent is to exit the company through a sale. In that case, you should start the process 5+ years from the transaction and incorporate the valuation and other key provisions in with your estate planning, updating the estate plan as information changes.

If you intend to have a multi-generational business, planning to incorporate family members, provide adequate training opportunities, and hand over the reins should also be an ongoing process.

Sitting down with a team including your financial advisor, attorney, and accountant to build a comprehensive estate plan is something you should do sooner rather than later.

The information contained herein is intended to be used for educational purposes only and is not exhaustive. Diversification and/or any strategy that may be discussed does not guarantee against investment losses but are intended to help manage risk and return. If applicable, historical discussions and/or opinions are not predictive of future events. The content is presented in good faith and has been drawn from sources believed to be reliable. This work is powered by Seven Group under the Terms of Service and may be a derivative of the original. More information can be found here. The content is not intended to be legal, tax or financial advice. Please consult a legal, tax or financial professional for information specific to your individual situation.

Eggs in How Many Baskets? Prioritizing Building Wealth While You Build Your Business

Don't have too many eggs in one basket when you're a business owner.

Employees of publicly traded companies are often granted company stock as part of the compensation package. From a portfolio management perspective, holding outsize amounts of stock in the same company that provides income can increase risk. If the business were to become wobbly, not only would the stock decrease in value, but the employee could also potentially find themselves out of a job. Employees who are granted stocks often mitigate this risk by selling some of the company stock and reinvesting it in other assets, to diversify growing wealth away from the source of income.

But what about when you own your business?

The situation becomes more complex. One strategy that’s often followed is to put everything except living expenses back into the business while you are growing it, and then sell part of the business or take on a strategic investor to help you begin to diversify elsewhere. Retirement planning is put on the back burner until the business has grown to a point where the business can be monetized.

We think there is a more thoughtful approach that may work for business owners.

The Key: Diversification

While it may seem like a good idea, relying solely on your business as your source of wealth can expose you to a lot more volatility than you think. Whether it’s saving for a rainy day, or longer-term goals like retirement, if all of your wealth is tied up in your business, your business dictates your moves. Creating and regularly adding to a separate investment portfolio may help diversify your assets.  And if you invest away from areas you are already exposed to in your business, it can be a powerful tool to help you smooth volatility across both your business and life.  For instance, if your business is vulnerable to cyclical sectors, you’ll want to create an investment portfolio that is defensive against those sectors. 

Retirement Savings Tax Advantages

There can be significant tax advantages to setting up the right kind of retirement plan for your business and ensuring that you set aside money to invest as close to the maximum as possible every year. While there are of course upfront fees and ongoing costs associated with formal retirement plans, they also allow you to save in a very tax-advantageous manner. Depending on your situation, a 401(k) plan and a cash balance plan are tools you can use to save and look towards a future income stream you can access without having to sell your business. They can also be a great way to attract and retain talented employees.

How About Timing?

When you’re putting everything back into your business with the idea that you’ll eventually fund your retirement by selling all or part of it, you’re essentially making two bets: That you’ll be able to sell when you are ready and not before, and that when you are ready the market for your business will be at a good point for an exit.  Having to liquidate early because you are no longer able to run the business, or having to sell when either the business is struggling or the market isn’t right, can limit the amount you realize. You only get to sell it once, and your retirement life will be dependent on what you realize. If you’ve planned for a source of retirement income away from your business, you’ll have more flexibility when it comes time to sell.

 The Bottom Line

Even as you’re building your business, it makes sense to think about your personal wealth as a completely different stream of future income. Thinking about diversification across your total asset profile can get you started on a journey to financial independence.

The information contained herein is intended to be used for educational purposes only and is not exhaustive.  Diversification and/or any strategy that may be discussed does not guarantee against investment losses but are intended to help manage risk and return.  If applicable, historical discussions and/or opinions are not predictive of future events.  The content is presented in good faith and has been drawn from sources believed to be reliable.  The content is not intended to be legal, tax or financial advice.  Please consult a legal, tax or financial professional for information specific to your individual situation. This work is powered by Seven Group under the Terms of Service and may be a derivative of the original. More information can be found here.