What to do if your business partner dies

What happens to a business partnership when one partner dies? Your business can fall apart if the proper planning and agreements aren’t in place before tragedy happens. Learn how you can protect your business and avoid losing all that you have achieved. 

A few questions to ask yourself in case your business partner dies:

• If my partner suddenly dies, what would happen to the business?
• How would this affect my family and the family of my business partner?
• Will you, your other partners, and the deceased’s family have conflicting priorities?
• Will suppliers and creditors extend the same credit and terms of business they always have, or will they begin to pull back?
• Will customers maintain their confidence in your products and services?
• Will important employees suddenly begin to leave?
• Can your partnership continue after the death?
  

After you've asked yourself these questions, you can begin to create or revisit a legally binding contract that spells out exactly what you and your partner(s) would want to happen if any of you were to die. This document can be as simple or complex as needed and can provide for virtually any contingency.

Your options if your business partner dies:

• Liquidate the business and distribute the remaining assets. 
  This may be your least favorite choice, considering the amount of time and money you have invested, as well as the sudden loss of steady income. Also, depending on the market and the economy, you might be forced to sell your business and its assets for a lot less than they’re worth.

• Take on your late partner’s heirs as new associates.
  This choice could be problematic, especially if the heirs are not as passionate, experienced, or willing to negotiate as your partner was.

• Sell out to the heirs.
  This option can lead to a lot of disheartening haggling over the purchase price, and you could have heartbreaking problems with the heirs that you never would have had with your partner.

• Buy out the heirs’ share of the business. 
  This is often the most practical choice. However, you must negotiate the price and terms, and then come up with the money. This is where a buy-sell arrangement can help.

Business partnership agreement

A properly arranged and funded agreement is a legally binding contract that spells out exactly what is to happen if one of the business’s owners dies. It generally calls for the survivors to buy the deceased owner's share in the business from his or her heirs. It should spell out the actual purchase price or provide an objective formula for determining the price.

Methods of funding an agreement. 

Option 1: Wait and pay cash. 

With this option, the surviving owner(s) use cash at the death of a co-owner to fund the buy-sell agreement. But there are several drawbacks:

• At the time of the death, funds may not be readily available for payment.
• A savings plan accumulates funds over time. What if funds are needed tomorrow?
• Will a savings plan be depleted if there are unforeseen expenses?
• Accumulation of cash may cause an accumulated-earnings tax problem.

Option 2: Wait and borrow funds. 

With this option, the surviving owner(s) borrow funds, usually from a bank, at the death of a co-owner to fund the buy-sell agreement. This, too, has drawbacks:

• Future growth may be slowed due to an increase in expenses (to repay the loan).
• The death of an owner may cause sales to decline, compounding the problem.
• The death of an owner may make it difficult to get approval for a loan.
• A surviving owner may have to sign for funds, exposing personal assets.
• Surviving owners pay dollar-for-dollar plus interest for the deceased's outstanding share of the business.

Option 3: Life insurance. 

Purchasing insurance can be a cost-effective funding option for a buy-sell agreement. Typically, a policy is taken out on the life of each owner so that when one owner dies, the surviving partners now have money to buy out the family of the deceased partner. Using insurance as a funding vehicle will provide the following benefits:

• Immediate availability of funds when the death occurs.
• The death benefit proceeds are generally federal income tax free.
• Premiums may be lower than the cost of repaying the loan interest would be.
• Premiums are pennies on the dollar compared with self-funding the payout to the family.

Whatever option works best for you, it helps to gather all the facts before you make a decision. Your legal and tax advisors, along with qualified insurance professionals, can help you create an arrangement that best fits your needs.

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This material is for informational purposes only. Neither New York Life nor its agents provide tax, legal, or accounting advice. Please consult your own tax, legal, or accounting professional before making any decisions.