The need for estate planning: A sign 'o the times

Prince, who died April 21, 2016, at the age of 57, was many things—a virtuoso guitar player, a Grammy-winning performer and songwriter, a successful record producer, a flamboyant stage presence, and one of the most famous Minnesotans of all time. And, in his death, he has added an unlikely accomplishment to his biography: a case study of how not to handle estate planning.

Prince’s lack of estate planning before his death has set off a series of lawsuits and legal complications that will dilute the value of his estate and could result in the assets being distributed in a way that likely wouldn’t align with Prince’s wishes.

While Prince and the typical fab shop owner couldn’t be more different, many lessons from Prince’s estate easily apply to business owners. Using song titles and lyrics from Prince’s remarkable career, we examine those lessons and look at how fab shop owners can use estate planning techniques to protect the value of their company; pass machinery, equipment, buildings, and intellectual property on to the next generation in a tax-efficient manner; and avoid many of the interpersonal issues and complications that can arise when the founder of a family-owned business dies.

You Don’t Have to Be Rich

A common misconception among owners of small businesses is that they don’t need to worry about estate planning unless the value of their assets exceeds $5.45 million. This is the amount of the federal estate tax exemption, which doubles to $10.9 million when used in conjunction with a spouse’s exemption.

If the total value of your assets is not more than $5.45 million, then what’s the point of going through the expense and effort of setting up an estate plan? First of all, many states have a state-level estate tax with an exemption amount significantly lower than the federal amount. Prince’s native Minnesota, for example, taxes estates valued at more than $1.6 million, and several states have even lower exemption levels.

Even if estate taxes don’t come into play, capital gains taxes and business continuity issues can erode the value of a business significantly when the ownership is passed to the next generation. If the plan is to pass company ownership on to family members, the use of trusts, discounting mechanisms, and other estate planning techniques can reduce the amount of associated estate and income taxes and maximize the amount of wealth that stays in the family.

If, however, your plan is to sell to a third party, going through the estate planning process and developing a clearly defined succession plan will help you identify and address any financial or business issues that could undermine the value of the company in the eyes of potential buyers, or even be obstacles to completing the sale. The earlier these potential issues are identified, the more time you will have to fix them.

I Get Delirious

One of the most important aspects of estate planning doesn’t necessarily have anything to do with money. In addition to determining how you want your assets to be distributed to your heirs, an estate plan should assign fiduciary powers to people you trust to make decisions on your behalf in the event of your death or incapacity. The fiduciary may be the executor of a will, trustee of a trust, or agent under a power of attorney for property or health care.

While these designations are important for everyone to have in place, they are especially important for business owners. The unexpected death of a business owner creates an immediate leadership and decision-making vacuum. If these fiduciary powers aren’t in place, the courts will have to designate someone to act on the deceased’s behalf, and most fab shops cannot afford to pause their operations while the courts make this determination. Furthermore, the failure to make these designations ahead of time runs the risk that the courts may appoint someone who is not knowledgeable about the business and/or ill-equipped to make these decisions at such a crucial time.

Controversy

Unfortunately, the fabrication industry is littered with examples of shops that fell apart because of family infighting. This risk is particularly acute when multiple children or grandchildren are involved. Intrigue about which child will be picked to run the company or who in the family will inherit what can be an enormous source of turmoil.

The unfortunate reality is that in many cases the business owner contributes to this drama by failing to put his or her plans in writing and communicate them to their family and business partners. To be sure, these can be difficult conversations. Some family members may not be happy with the plan or may feel slighted. But avoiding these conversations only creates more pain in the long run. And in many cases, the longer you wait to implement an estate plan, the fewer options you will have; this is particularly true for businesses that are growing rapidly.

Proactively addressing these questions and communicating the plan go a long way in minimizing hurt feelings and preventing painful—both emotionally and financially—infighting that can occur after the business owner is gone. Your failure to put your testamentary wishes in writing makes the administration of your estate infinitely more complex. It also likely results in the exclusion of one or more individuals or charities you intended to benefit. And it can lead to protracted legal proceedings that erode the value of the very assets you intended to distribute to family, friends, and favorite charities.

I Could Never Take the Place of Your Man

Succession planning is an essential part of estate planning for business owners, and the need for succession planning is particularly great in the fabrication industry. Many fab shop owners who are now nearing retirement saw their children take a different career path. Seeing their parents’ companies struggle in the wake of globalization, the dot-com crash, and the Great Recession, these children decided not to go into the family business. As a result, the owners have had to look outside the family for the next generation of leadership or sell to a private equity firm or strategic acquirer.

Regardless of whether the plan is to pass the baton to a child or an existing employee or sell to a third party, it is important to get these plans in writing and begin planning for the transition. For many fab shops, much of the value of the business is held in the owner’s head. The owner’s relationships with customers and vendors, knowledge of the company’s bookkeeping and contractual intricacies, and technical know-how often are just as valuable as the buildings, machinery, and other equipment. If that knowledge and those relationships haven’t been transferred to the next leader, it is likely they will evaporate upon the owner’s death or retirement.

In the case of a sale to a private equity firm or strategic buyer, the absence of this information will lead the buyer to discount the value of the company significantly. For this reason it is critical for you to get your intellectual capital on paper or transfer it to your successor once he or she has been identified.

Diamonds and Pearls

For many people, a big part of their estate will be represented by physical assets, such as homes, cars, and jewelry. For fab shop owners, much of the value of their companies is made up of buildings and equipment. As you think about estate planning, it is important to think about how these assets are titled and valued. Working with your accountant to appraise the value of these physical assets is essential to understanding how much the company is worth.

In addition to Prince’s financial and physical assets, a large portion of his estate is represented by the ownership of the songs he wrote and recorded. And for some fab shop owners, intellectual property—in the form of patents, logos, and proprietary development processes—can represent a substantial portion of the value of the company. When intellectual property is involved, be proactive and make sure your estate plan accounts for it properly.

The first step is to work with an attorney to take steps to protect your legal claim to the intellectual property via trademark, copyright, or other means. You might have product or process development teams that use proprietary techniques. In these cases, it is important for you to work with an attorney to clarify who is the owner of the process and whether that process is something that can be protected.

Party Like It’s 1999

A concern that some business owners have when it comes to estate planning is how receiving a significant amount of money can affect a descendant’s mindset or work ethic. While most fab shops are small enough that their owners don’t worry about creating “trust fund babies,” it is worth noting that inheriting even relatively small amounts of money can have unintended consequences for some descendants, especially ones in their teenage years or early 20s.

With proper estate planning, you can create structures that make the assets available to heirs according to a schedule that makes sense and protects the descendants from themselves. For example, a trust could make half of the assets available to the heir when the heir turns 25 and the other half available when the heir turns 35. Or, a trust could stipulate that a child’s inheritance of the ownership of a company is conditional on the child earning a college degree.

Act Your Age, Not Your Shoe Size

In estate planning and succession planning, as in most things in life, it is never too early to start thinking about the future. From a strategic standpoint, more time gives you more options for deciding how to best structure the transition. From a financial standpoint, starting early provides more opportunity to utilize the currently available gift, estate, and income tax benefits by, among other things, transferring appreciating assets out of your estate to family members.

The importance of planning ahead also applies to thinking about how to fund your retirement. Some fab shop owners make the mistake of failing to establish an outside retirement plan, assuming that they will be able to draw on the cash flows of the business to support themselves throughout retirement. This approach can easily backfire if the children you expected to buy the business don’t have enough cash to do so, or if you aren’t able to find a third-party buyer. Even if you do have a child who is able to take control of the business, he or she might resent having a significant portion of the company’s cash flows siphoned off to support your retirement lifestyle.

With a strong estate plan and business succession plan in place, you can prepare your company, your family, and your employees for a successful future. If you already have an estate and succession plan but have not reviewed it in the last three years, now is a good time to do so. The next time you find yourself tapping your toes to a Prince song, use that as a reminder of the importance of securing your company’s and your family’s financial future.

Prince photo licensed under the Creative Commons Attribution-Share Alike 4.0, creativecommons.org.