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Is a will or trust right for business succession?

May 10, 2021
Pen and Calendar

Both a will and a trust work to transfer a business owner’s interest to beneficiaries. Which works best and why?

By Dylan Metzner.

Wills and trusts are legal documents that provide for a smooth transfer of assets. When and how they accomplish this mission differs based on the intended outcome and whether the ownership transfer takes place prior to or following a death.

Both a will and a trust work to transfer a business owner’s interest to beneficiaries. But when additional protections, including a smooth transition upon the owner’s incapacity or death, are necessary, the go-to is a trust. Planning, execution and funding are three areas to cover in defining business succession using either a will or trust.

Will Planning vs. Trust Planning

Wills and trusts differ in timing, execution and coverage that when assessed against goals, create a clear winner when selecting the best vehicle for business succession.

At its most basic, a will is a legal document that you write during your life but has no effect until your death. A will directs how assets that make up your probate estate are to be distributed after your death.

A trust, on the other hand, is a legal document that takes effect once the trust instrument is finalized and signed. A trust directs how assets that are held by the trust are to be administered and distributed. Since trusts usually avoid probate, transitioning assets and control at death generally occurs quicker than would otherwise result through the probate process.

When an individual owns a business, a will can outline how the business interest will be distributed after the owner’s death. Wills, however, do not cover an owner who is alive but incapacitated. Trusts, on the other hand, not only cover what happens to the trust assets after the owner’s death but also cover what happens during the owner’s incapacity.

Incapacity is an often-overlooked aspect of estate planning. When a business owner becomes incapacitated, someone needs to step-in and manage the owner’s interest in the business. If the owner has not created a legal structure to account for who will manage the owner’s interest in the event of incapacity, then upon the owner’s incapacity, a Conservatorship is likely to be  established for the incapacitated owner, requiring a Court proceeding to appoint the Conservator and ongoing Court involvement for the duration of the Conservatorship.

To avoid a potential Conservatorship appointment to manage an incapacitated owner’s business interest, a business owner could place their interest in a form of trust known as a revocable trust. In general, the business owner (i) creates the trust, and, (ii) is solely in charge of and receives the sole benefit from the assets held in the trust during the owner’s lifetime.  The revocable trust should identify who is to step in and takeover the management of the trust in the event the business owner becomes incapacitated or dies. When incapacity or death occurs, the successor trustee is able to quickly take over and manage the trust assets.

After the death of the owner, the owner’s interest in the business can pass either pursuant to the owner’s will or a trust. In either instrument, an owner should identify who receives the interest (beneficiary) and whether the interest will pass to the beneficiary outright or in a testamentary trust (one that is written during the owner’s life but not effective until the owner’s death).  Testamentary trusts can be used to transfer the business to children or other interests while protecting the interest from the creditors of the beneficiary.

Executing and Funding a NextGen Transfer

Considerations surrounding the transfer of a business go beyond who is to receive the interest.  Oftentimes, owners view their business as another child. They want to ensure their business survives beyond them, not just to benefit their family but also to ensure employees and customers will continue to be well cared for.

Business owner’s must balance the issues around what is in the best interest of business continuation against what the family may think is in their best interest. Issues compound quickly when the business comprises the majority of the owner’s net worth and the owner has multiple children and wants to treat the children “fairly”.  Fair does not always mean equal. In some cases, the fairest succession solution is an unequal distribution of assets.

Many legal disputes involving trusts and estates are caused by adult children who believe they did not receive their “fair share”. A client with a daughter working in the business and a son who is a teacher and has no involvement with the business can have different reactions to their bequests. For example, if the business is left in equal shares to the children, the daughter can resent having to pay profit distributions her brother who is doing nothing to generate those profits. Likewise, the son may feel like his sister controls the inheritance because she is in charge of the business.

A fair resolution might be for the client to leave the business to the daughter and non-business assets, such as cash accounts and real estate, to the son, creating a split that does not co-mingle assets after death. Even though the business is worth more in the long run as a going concern, it is illiquid. Thus, the daughter who is involved in the business receives an illiquid asset but she presumably will understand the cashflow of the business. The teacher son, on the other hand, would receive liquid assets and is not reliant of his sister.

Beneficiaries may not always be happy with a fair but inequitable distribution. A solution like this proactively addresses family dynamics and pain points while reducing the risk of conflict and giving the business the greatest chance of ongoing success.

Business succession planning is not a last-minute task. The planning involves a lot of forward-looking thought and full consideration of available alternatives before decisions are made. Review your options with a qualified private wealth attorney before selecting the right vehicle for business succession success.

Dylan Metzner is a private wealth attorney with Denver-based Jones & Keller executing advanced trust and estate planning strategies for individuals, families and businesses. Reach out to Dylan at dmetzner@joneskeller.com.

This information is not intended as legal advice. Readers should seek specific legal advice before acting with regard to the matters addressed above.