Business owners spend years building something valuable. They create systems, develop customers, hire employees, pay vendors, buy equipment, sign leases, open accounts, and hopefully build something that has value beyond just the income it produces from month to month.
But one of the most important questions often gets ignored: What actually happens to that business when the owner dies?
A lot of business owners assume that if the business is already in a corporation or limited liability company, then the probate problem has been solved. Unfortunately, that isn’t necessarily true.
Forming an LLC or corporation may provide liability protection and other important advantages, but it doesn’t automatically mean that the owner’s interest in that business avoids probate. Estate planning and business planning overlap, but they aren’t the same thing, and if the two aren’t coordinated, the death of a business owner can create exactly the kind of disruption everyone was trying to avoid.
Does An LLC or Corporation Automatically Avoid Probate?
If your business is organized as a corporation, then you generally own shares in that corporation. If your business is organized as an LLC, then you generally own a membership interest in that LLC. Those shares or membership interests are assets just like other property you own, and if they are still held in your individual name when you die, they may have to pass through probate.
That means the corporation or LLC may continue to exist as a legal entity, but the ownership interest in that entity can still become trapped in the probate process. This distinction matters because businesses do not stop operating just because the owner died. Employees still expect to be paid, vendors still send invoices, rent and insurance still come due, loans still have to be serviced, and customers still expect someone to answer the phone and keep things moving.
Depending on how the business was structured, the death of the owner can also create problems with access to business accounts and authority over day-to-day operations. Banks and other institutions may require proof of who has legal authority to act, and if that authority is unclear or tied up in probate, access to money can be delayed or restricted.
A profitable business can suddenly have trouble paying routine expenses simply because no one has immediate authority to step into the owner’s shoes.
That’s why saying, “My business is in an LLC, so it avoids probate,” can create a false sense of security. The business entity may survive, but the ownership of that entity still has to be addressed.
A Sole Proprietorship Can Create an Even Bigger Problem
The situation can be even more complicated when the business isn’t operated through an LLC or corporation at all. In that case, the business owner may personally own nearly everything associated with the business, including bank accounts, equipment, vehicles, inventory, intellectual property, contracts, real estate, and other assets used to operate the company.
If those assets are owned individually, then each one may have to be dealt with through the owner’s estate unless some other planning has been put in place. Certain assets may be assigned to a revocable living trust. Some financial accounts may permit payable-on-death or transfer-on-death beneficiary designations. Other assets may have their own methods for transferring outside probate.
The problem is that avoiding probate on individual assets isn’t enough if the planning causes the business itself to be split apart.
Suppose one business account has one child named as beneficiary, equipment has been assigned to a trust for another child, and other business property passes under the Will equally among three children. Every asset may have technically gone somewhere, but the business that once functioned as a single unit may now be divided among different people with different rights and different interests.
Instead of preserving the business, the estate plan may unintentionally dismantle it.
That’s why good planning has to look beyond the question of whether a particular asset avoids probate. The more important question is whether the entire business ends up where the owner intended and whether the people receiving it can actually keep it operating.
The Better Approach Is to Coordinate the Business and the Estate Plan
For many business owners, the better structure involves two different layers of protection.
The first layer is the business entity itself. Depending on the nature of the business and the advice of the owner’s accountant and other professionals, that may mean operating through an LLC, corporation, or another appropriate entity that provides the right combination of liability protection, tax treatment, and management flexibility.
The second layer is making sure the ownership interest in that business is properly coordinated with the estate plan. If the owner uses a revocable living trust, that will often mean transferring the corporate shares or LLC membership interest into the trust.
The practical advantage is that the trust then owns the business interest rather than the individual owner holding it personally. When the owner dies, the successor trustee can step in and manage or distribute that interest according to the instructions already contained in the trust. Instead of waiting for probate to establish who has authority, the transition has already been planned in advance.
That doesn’t mean every business should automatically be transferred into every trust. The business structure, tax issues, lending arrangements, ownership restrictions, and governing documents all have to be reviewed. But from an estate planning standpoint, the objective is simple: protect the business while the owner is alive, and make sure the ownership of that business can pass without unnecessary disruption when the owner dies.
The Business Agreements Have to Allow the Estate Plan to Work
There’s another issue that business owners frequently miss. Even if the estate plan is designed correctly, the company’s own governing documents may contain restrictions that interfere with the plan.
If a corporation has a shareholder agreement, that agreement should be reviewed to make sure it allows shares to be transferred into the shareholder’s revocable living trust when appropriate. It doesn’t make much sense to create a trust designed to own the stock if the shareholder agreement prohibits the transfer.
The same issue often arises with LLC Operating Agreements, and sometimes the restrictions are even tighter. Operating Agreements are frequently written to prevent members from freely transferring their membership interests because the other owners do not want a stranger suddenly becoming part of the company.
That restriction makes sense when someone is trying to sell an interest to an unrelated third party, but it can create problems when the transfer is being made purely for estate planning purposes.
A better Operating Agreement can distinguish between an outside transfer and a transfer into an entity that remains under the existing member’s control. That may include a revocable living trust, a Family Limited Partnership, or another approved estate planning entity so long as the current member continues to control the interest through that structure.
The goal isn’t to eliminate reasonable transfer restrictions. The goal is to make sure those restrictions do not accidentally prevent the owners from completing basic estate planning.
Your Business Plan and Estate Plan Should Not Be Separate Worlds
Business planning and estate planning are often handled as though they are completely unrelated. They aren’t. The business entity may protect the operation from certain liabilities, but it doesn’t automatically control what happens to the owner’s interest when that owner dies. At the same time, a revocable living trust can be an extremely effective estate planning tool, but only if the business ownership is actually coordinated with the trust.
The best result is when both sides work together. The business remains in an appropriate entity for liability and operational purposes, while the ownership of that entity is structured so it can avoid probate and pass according to a clear succession plan. The governing documents should support that planning rather than interfere with it, and the entire plan should be designed so the business remains intact instead of being divided asset by asset after the owner’s death.
Toward the end of this year, I will be doing a three-part series on estate planning for business owners that looks more closely at how business ownership, succession planning, and estate planning fit together. Because if you spend years building a business, the last thing you want is for poor estate planning to create chaos at the exact moment your family and employees can least afford it.
For more information on businesses and estate planning, check out the YouTube
channel at YouTube.com/nclawyer.