What will happen to your business when your partner dies? Without adequate planning, the partnership no longer exists as a legal business entity – except for the purpose of winding up its affairs. When a partner dies, the surviving partner has two alternatives: liquidate or reorganize. Liquidation is not usually a good option, as the business will have to be sold quickly and for only a fraction of the value it had as a “going concern.” In most cases, goodwill is lost entirely.
Reorganization generally is a better alternative. The reorganization of a partnership typically follows one of three scenarios:
- Your partner’s heirs become new partners.
- Your partner’s heirs sell their interest to someone else.
- Your partner’s heirs buy your interest in the business.
The best solution is to plan ahead for the sale of your business upon the death of a partner. This can be accomplished with a buy-sell agreement. A properly structured buy-sell agreement can establish a pre-determined price for the business, as well as provide funds to buy the business from the heirs. This figure also can establish a value for estate tax purposes.
Many business owners have a difficult time determining a realistic fair market value for their business. Partners can use a number of valuation methods to estimate the value of their interest in the business. No one method will work in every case, but one, or a combination of several, should serve the needs of most business owners. No matter which method you use to value the partnership, there is one important factor you should keep in mind: The buy-sell agreement should make provisions for future valuations of the business – either through periodic updating or use of a formula. That is because a fair market value that is “just right” today may be too low next year and entirely inadequate in five years. When partners devote the bulk of their time, effort and ability to the operation of a business, its fair market value usually continues to increase. This constant appreciation should be taken into consideration when valuing the business.