Here’s a test for the sole proprietors out there. Look over your business plan. Analyze the business model, mission plan, company profile, and revenue streams. When finished, ask this question: “If I were to pass on, how can my survivors benefit from the time and effort I put into this venture?” In many cases they don’t, but there are ways a business owner can protect assets should something unforeseen occur.
The sole proprietorship is one of the more common small business structures. According to the U.S. Census Bureau, nearly 90% of the 823,500 African American-owned businesses in 1997 (the most recent census data available) were sole proprietorships. But in the case of a sole proprietor’s death, these businesses are usually dissolved. Heirs are often left scrambling to pay off debt and tax liabilities, or they are forced to sell assets at a deep discount to raise needed cash.
“Basically the skill and experience of the actual owner is what you base the whole company on,” says Patrick Olearcek, director of estate and business planning for MassMutual Financial Group in Hartford, Connecticut. “And you have to have some kind of planning because if you die or become disabled, there’s a good chance you’ll have immediate termination [of contracts]. Your family could get stuck with selling assets of property at 50% of what they’re valued because they’re forced to sell stuff to pay off the estate.”
Because a sole proprietorship is simply a single individual carrying on a business, the individual owner is liable for all debts and other obligations of the business. Legally, a sole proprietorship is totally identified with the owner. Should the owner die, the business enterprise terminates, leaving only the assets of the business such as, equipment, accounts receivable, and real property.
So what can be done to prevent this? A must for any business owner is a succession plan, which is provided by many financial planning firms. A succession plan enables the proprietor to outline the events to take place upon his or her death, or inability to work. Options include transferring business assets to a family member or trusted person. In the event that the heirs do not have the aptitude or skills to run the business, these agreements can be modified so that an outside buyer (who would go on to manage the business) acquires a percentage of the business, with the remaining stake distributed among family members. This enables survivors, who may not have the skills to run the business, to maintain an interest in the venture without the managerial responsibilities.
But how should one go about putting a succession plan into action? “The right way is really to not engage a lawyer but to engage a tax attorney,” suggests Richard Levychin, a CPA and partner with the New York-based accounting firm Kahn Boyd Levychin. “It’s important from a legal standpoint that the transaction be structured properly, but you can’t just go ahead and structure it [solely] from a legal standpoint without being cognizant of the tax implications.”