Dear Mr. Premack: Ten years ago, a good friend and I decided to go into business together. She knew a lot about real estate, and we both had good jobs with money to invest. We set up an LLC, and have used it to purchase a number of rental properties. The cash flow has been positive, and now that property values are better we may sell a few for the gains. Lately, I’ve been concerned about what would happen to my investment should either of us die. Frankly, I don’t ever want to be in business with my friend’s husband (and I know that she would leave her share to him should she die). What can we do so that we can preserve our economic gains but stay out of business with each other’s spouses? – TW
The word succeed has two meanings: 1) to attain your goals, or 2) to become a replacement. When you went into business with your friend, you wisely formed an LLC (limited liability company). Each of you became “members” (the owner/operators of the company). Your business arrangement sounds like it has allowed you to attain your goals: you have remained friends and you are making a profit, with the value of your investment increasing. However, all good things must come to an end; it is possible (as you raised in your letter) that one of you could die while the LLC is still in full operation.
Your LLC should have an “operating agreement” that specifies exactly how the company is to be run. Your agreement should provide for the ongoing management of the company, either naming one of you as “manager” or allowing both of you to run the company cooperatively as its members. It specifies your financial contributions to the company and how your profits will be divided. It declares how the company will be treated for income tax purposes. All of those are important issues that must be addressed for the company to succeed. But the agreement should go one step farther and determine not just how to succeed, but how succession will be handled should either member die.
One option, of course, is for both members to agree that spouses can inherit the share of a deceased member. To do so, however, both members must trust and be willing to do business with the other partner’s spouse. Depending on personalities, skills, and personal preferences, a member may be willing to be in business with the spouse or may think it would be a disastrous mistake.
Your letter indicates that you prefer not to be in business with the other spouse. Consequently, the operating agreement should include a buy-sell provision. This could be expressed as a requirement that each member’s estate sell his/her interest to the surviving member, with the surviving member financing the buy-out from cash flow or sale of assets. Or, it could be expressed as a requirement that each member buying a life insurance policy on the other’s life, with the proceeds to be used to buy the deceased member’s interest from his/her estate. Or, it could be expressed as a requirement that the LLC itself purchase life insurance on both members so that the LLC itself would redeem a deceased member’s interest, leaving only one member as sole owner of the company after the other’s death.
Whichever route you select, you and the other member must coordinate the terms of the operating agreement with your personal estate plans. You should both have Wills or Trusts. If Wills, they must reflect the agreement’s scheme for handling succession in the company. If your company membership interest is owned by a Trust, the Trust must contain terms that comply with the operating agreement’s succession scheme. Visit with your experienced estate planning attorney for a review of your LLC’s operating agreement and to conform your estate plan and insurance to enact a succession plan that will allow the company continued success.
Paul Premack is a Certified Elder Law Attorney in San Antonio. His firm has offices in Texas and Washington, and handles estate planning for all ages, probate law and business entity formation issues.