Death is unexpected for many people, but avoidable for none. Likewise, a sudden disability is never planned for. For business owners, being prepared for the unexpected is an important responsibility of stewardship. Sole proprietors have special issues, since there are no partners that can carry on in their stead.

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Businesses are depended upon by a large number of people for many things and become part of people’s lives. Owners who do not plan shortchange those they leave behind, often saddling them with unnecessary and unfavorable consequences. Making plans for death is difficult and unpleasant, but it is a necessary part of life. It is also a courtesy for those closest to the owners and for those who contributed to their success.

The following matters should be carefully considered by sole proprieters, ideally with the aid and direction of their CPA financial planners.

Consequences of Not Having a Plan

The business will need to be liquidated or sold, and without a plan, this will be handled by someone who lacks the necessary knowledge or authorization, which will cause delays. Any sale or liquidation will also be done under stress, with much lower receipts than could have been obtained with an orderly plan.

Employees will need to be let go; for those who stay, responsibilities and loyalties will not be clear. Long-term employees might not receive minimal severance payments or will quickly start looking for a new job and will not be available to help with the process of selling or unwinding the business.

Customers expecting deliveries or services will be left unaware of what they will receive and when. Customer projects might have to be cancelled with penalties or continued at a loss, and contracts might be defaulted on with undue costs. Leases will encumber asset transfers and will carry penalties if broken or ongoing costs if maintained without a viable operating business able to make continuing payments. Loan repayments might also be in doubt, sometimes forcing the bank to act precipitously.

Family conflicts are more likely to arise; litigation will be more probable than with planned alternatives. Attorneys will need to be engaged, as will valuation experts and other specialists to assist in the continuance, sale, or liquidation. A surrogate’s court may appoint outsiders to run, liquidate, or oversee the business, with added costs including bonding, legal fees, accounting costs, and reporting fees.

Accounts receivable will need to be collected, inventory sold, and work in progress finished or penalized if abandoned. Liabilities will also need to be dealt with on a timely basis. Tax returns will need to be filed and accountings made to beneficiaries and the court.

None of these problems will disappear if ignored; rather, they will fester and grow. Putting simple plans in place can make unpleasant necessary actions easier and less costly to bear. Planning has no effect on an owner’s independence or actions and has no consequence in the ordinary running of the business.

Contingency Plan

The following points can be used to jump-start a contingency plan. The goal is to enable someone qualified to quickly assume control of the business and continue operations or start an orderly liquidation in the event of a sudden death or disability.

First steps.

Ownership should be placed into a living trust. The business owner can the be trustee as long as he is able to perform all duties. Someone of the owner’s choosing should be selected as the alternate trustee, who will become the trustee upon the owner’s death or disability (which should be defined in the trust agreement).

An alternative to a living trust for disability is a specific durable power of attorney. This will not, however, be effective in the case of death. Another alternative, also less effective, is to elect another officer, for example an assistant secretary, with bank signatory power.

Either as part of the living trust or in a separate memorandum of instructions, the business owner should spell out her wishes of how the business should be operated. These can only be suggestions, however, since things do change and the trustee or person acting under the power of attorney should not be bound by what is written in the memorandum.

Critical decisions.

The trustee or other person operating the business as owner, together with the person controlling the trust, should arrange to become a signatory on any business bank accounts. The owner should identify various key people to be consulted in hiring and firing, scheduling, billing and contacting customers, and any other issues identified in meetings with the alternate trustee. These meetings should take place at minimum six-month intervals.

Compensation should be established for the trustee based on a fixed amount for oversight and responsibility and a payment arrangement based on either time, value creation, or staff working on the company’s activities. In addition, arrangements should be made for the trustee to receive a payment for assisting in the sale of the company if necessary.

In the event of death or disability, payroll payments will need to be made as scheduled. Customers or clients will need to be continually served and assured of the business’s continuity. In the case of the owner’s disability, cash-flow distributions to the owner’s family will need to be made to provide for any necessary care. This should be done in conjunction with the healthcare proxy person. If the owner’s family is dependent on cash flow from the business, arrangements for distributions will need to be made quickly. Communications with family members will need to be kept open and transparent, and they should be apprised of any arrangements when they are made (i.e., before death or disability).

In the case of prolonged disability or death, a decision will need to be made whether to sell or continue the business or to hire a general manager to handle day-to-day operations. Long-term decisions such as lease renewals, pricing changes, or hiring permanent management personnel, with exception of a general manager, should be deferred as much as possible. Any plan should be in writing and discussed with the company’s banker (if large lines of credit exist) and any other interested party.

Arrangements to sell the business should begin only after operations are stabilized. While still able, the owner should identify major competitors and others in the industry that might be potential buyers. The trustee will need to engage a professional to prepare a selling memorandum or book and initiate contact with such potential buyers. If these companies are not practical purchasers, or if assistance is needed to find a buyer, then a business broker or an investment banker should be engaged.

Preplanning.

For long-range disaster planning, the owner should assemble a board of directors or advisors. Complete instructions for operating or selling the company, including all the information a representative would need to know, should be written out and kept in an easy-to-access location. Included in the instructions should be documentation of passwords, processes, and procedures; comments about individual employees, customers, and customer contact people; and a list of the owner’s typical daily and weekly duties.

If ownership is placed in a living trust, then the owner’s will will not be operative with respect to the business. The owner’s primary concern should be the continuation of the business and maintenance of cash flow. A second concern should be maximizing the value for the owner if he is permanently disabled or for his family if he dies, or reducing wind-down costs as much as possible. The owner should consider life insurance as a method of providing for wealth transfer independent of the business and to assure bankers of the repayment of outstanding loans. A life insurance trust should be made the owner of the policy, with the bank as a beneficiary to the extent that there is outstanding debt. The specifics of this arrangement will need to be worked out, including consideration of estate and income taxes, especially with the repayment of the bank loan.

Owners who do not plan shortchange those they leave behind, often saddling them with unnecessary and unfavorable consequences.

Better to Be Prepared

No one likes to admit it, but life is precarious. A contingency plan that can be implemented almost immediately upon death or disability needs to be established for the sake of the business and the people involved. The costs of setting up such a plan are an investment that will provide assurance to customers, vendors, lenders, family, and the owner herself, even if the plan never needs to be used. CPAs should use this article as a starting point to establish a plan that will work for each individual client.

Sidney Kess, JD, LLM, CPA is of counsel to Kostelanetz & Fink. He is a member of the NYSSCPA Hall of Fame and was awarded the Society’s Outstanding CPA in Education Award in May 2015. He is also a member of The CPA Journal Editorial Board.
Edward Mendlowitz, CPA/PFS, ABV is partner at WithumSmith+Brown, PC. He is also the author of a twice-weekly blog posted at http://www.partners-network.com.