Partnerships: Is There Life After Death?
Have you thought about what will happen to your business when your partner dies? If no other arrangements have been made, the partnership will no longer exist as a legal business organization except for the purpose of winding up its affairs.
When a partner dies, the survivors have only two alternatives: they must either liquidate or reorganize.
Liquidation usually is not a good solution. The business generally will have to be sold quickly and for only a fraction of the value it had as a "going concern." In most cases, good will is lost entirely. Physical assets may bring little more than one-fourth of their true value.
Reorganization generally is a better answer. The reorganization of a partnership usually follows one of four scenarios:
1. Your partner's heir(s) become new partners. This plan may or may not work. One or more of the heirs might be a minor, and few of the heirs, if any, will have been regular employees of your business. They may not have the knowledge and experience needed to be a partner.
2. Your partner's heir(s) sell their interest to someone else. This means you may not have a say in who your new partner will be.
3. Your partner's heir(s) buy your interest in the business. In most cases, the heirs simply can't afford to buy the business. Even if they can afford to buy, they may not be willing to pay a price adequately reflecting the value of the business.
4. Your partner's heir(s) sell their interest to you. This would be an ideal solution if the surviving partners can raise a sufficient amount of cash and if they can agree on the terms of the purchase with the heirs.
The best solution is to plan ahead for the sale of your business upon the death of a partner. This can be accomplished with a buy-sell agreement.
A properly structured buy-sell agreement can establish the business value and ensure the continuation of the business by the surviving owners. In addition, the agreement generally establishes a pre-determined price for the business, as well as provides the money to actually buy the business from the heirs.
Validate Your Business
Many business owners have a difficult time determining a realistic fair market value for their business. Partners can use a number of valuation methods to estimate the value of their interest in the business. No one method will work in every case but one, or a combination of several, should serve the needs of most business owners.
No matter which method you use to value the partnership, there is one important factor you should keep in mind: The buy-sell agreement should make provisions for future valuations of the business – either through periodic updating or use of a formula. That is because a fair market value that is "just right" today may be too low next year and entirely inadequate in five years. When partners devote the bulk of their time, effort and ability to the operation of a business, its fair market value usually continues to increase. This constant appreciation should be taken into consideration when valuing the business.
Plan for the Future
Planning today for the future of your business helps protects you, your partner and your families. You know exactly what will happen if a partner dies...the purchase price, the funding arrangements, etc. It allows you to continue in business and provides the partner's heir(s) with immediate cash. There may be life after death for partnerships – when partners plan ahead.
Dave Starr is Regional Managing Director with Principal Financial Group in Sioux Falls.