Operating Agreement
Having a succession plan for your business is a good idea. When an LLC exists, it’s crucial to have an operating agreement. The terms of an operating agreement will typically trump the terms in a will and the default rules for an LLC governed by state law. In other words, an operating agreement is very important. So what does an operating agreement say? It can state the percentages of each member’s ownership interest, it can show voting rights and responsibilities can establish capital contributions, and how each member will receive profit and losses. But for now, the important provisions we are going to consider are the procedures established upon the death of a member. Keep in mind that this is a general overview of some options. Many factors should be considered for your business: such as the entity structure (partnership, s corp, c corp, sole practitioner, etc.), how many owners are in the company, the type of relationship with the owners (is it your spouse, friend, or strictly a business associate). But for now, we’re going to talk about a few common strategies for LLCs we can do to avoid probate and protect your future assets for your loved ones.
Transfer-on-Death
So first, we have what we call a Transfer on Death or a (TOD) designation. This is a provision we can insert into the operating agreement of the LLC. This allows the deceased member’s ownership to transfer fairly effortlessly. A TOD designation can be changed and/or revoked at any time prior to death. This type of provision works great if the LLC is a sole membership LLC. However, if there are multiple members, you need to strongly consider who the beneficiary designation will be. For instance, maybe your choice to take over the company when you pass away wouldn’t get along with your current business partner. Or, maybe your current business partner might designate his son when he dies. Maybe his son is a nice kid, but he sleeps all day and has no interest in hard work. Do you want that to be your new business partner? TODs can be a great, simple solution, or a terrible headache.
Buy-Sell Agreement
Another option is a buy-sell agreement. This agreement can be within the operating agreement itself or a standalone agreement. A buy-sell agreement can be a great device to plan for the death of a member. This writing can control (1) who can buy a deceased member’s share of the LLC; (2) what circumstances would trigger the buy-sell agreement. Here, we’re considering death as the circumstance, but you can also plan for divorce, bankruptcy, or retirement of a member; and (3) what price will be paid for a deceased member’s interest in the LLC. This is a very important point that I will discuss in a moment.
Trust
Finally, you should consider a trust. A trust offers flexibility that a TOD and buy-sell agreement can’t offer. Upon a member’s death, the trust may be funded by the deceased member’s share. From there, the trust may then govern how the assets will ultimately be distributed to the beneficiaries. This can be a great alternative to full outright distribution. It’s important to clarify that in order to make a trust a member of the LLC, you would put the entire LLC into the trust, as opposed to the LLC’s individual assets. However, depending on the LLC, it can be a good idea to keep the LLC in your individual name and prepare an assignment that is separate from the operating agreement. The short assignment would simply state that the entire share of your individual ownership has been assigned to your trust, but this assignment would not be directly part of the operating agreement. That way, the LLC should not have any issues opening a bank account or obtaining a loan. Bankers can become wary when they start seeing trust language in an operating agreement. This can be a handy alternative to avoid confusion.
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