What Happens to your LLC when you Die

Headstone View by Augapfel from Flickr (Creative Commons License)

Headstone View by Augapfel from Flickr (Creative Commons License)

When you own an LLC or part of an LLC, you own property. This is property that will be part of your estate when you die. If someone came to me and said their business partner just died and they’re not sure what that means for the business, I would initially have two questions.

  • What does your operating agreement say in regards to this situation?
  • What does the deceased’s estate plan say happens to their portion of the business?

Hopefully both of these documents exist and give clear instructions. If you don’t have an operating agreement and the person didn’t have an estate plan, their portion of the business will pass to their relatives like the rest of their estate per that state’s law. Most likely, if the person was married, their portion of the business would go to their spouse. If they didn’t have a spouse, it would go to their kids. If they didn’t have a spouse or kids, it would go to their parents.

When I draft an operating agreement for LLC owners, I make them answer the hard questions like what happens if an owner dies or gets disabled and document their plans for addressing those situations at the beginning of their business relationship so they won’t be scrambling when they find themselves facing these issues.

If you are a sole LLC owner, you don’t need an operating agreement that tells you how you’re going to run the business, but you may want one to thoroughly document what you want to happen to the business when you become disabled or die. Make sure you document the pertinent information like where keys, passwords, and bank accounts are so your employees or loved ones can take over or wind up the business.

Once you have your estate plan and operating agreement in place, make sure you tell your family and whoever else may need to know where you put it so they can carry out your wishes. My Wills and Estates professor (who is a brilliant estate planning attorney) suggests you put them in a fire-proof and waterproof safe with the door unlocked (or the key in the lock). That way the documents are safe but if a thief gets into your business or house, they will quickly see that it doesn’t contain anything of value to them and leave it.

It’s hard to think about what should happen to your business if you die. If you work in an industry (like law) where a person needs a specific credential to be an owner, you may not be able to keep the business in the family but they could be charged with closing down your operation. Otherwise you will have to decide if you want the business to go to a family member, an employee, or a combination of people. You ultimately won’t have control over whether the business continues to exist, but you can put the documents in place to try to make it happen.

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How To Start a Business in Arizona

National Geospatial-Intelligence Agency Ribbon Cutting by US Army Corps of Engineers, Carter Law Firm, Ruth Carter

National Geospatial-Intelligence Agency Ribbon Cutting by US Army Corps of Engineers

This week I had two speaking engagements on the basics of starting a business in Arizona. I thought I’d expand my list of tips into the ideal timeline an entrepreneur should follow for setting up their business.

  1. Figure out what type of business you want to have.
  2. Select a name for your business. From a trademark registration perspective, it’s best to pick a name that contains a word or words that don’t already exist. Also be mindful of any business name restrictions that exist in your industry.
  3. Do a search on the U.S. Patent and Trademark Office (USPTO) website to see if someone in a similar business has registered a similar name for their business. If they have, they can prevent you from using your desired trade name. Run a Google search as well to see if someone has a similar name but hasn’t registered it with the USPTO.
  4. Create a business entity by sending the appropriate form and payment to the Arizona Corporation Commission.
  5. Open a bank account for your business. Never use your personal accounts for business expenses or your business accounts for personal expenses.
  6. If you have more than one owner, create an operating agreement. This is a contract that dictates how the company is owned, how you will run your business, and how you will resolve problems. You need this no matter who your partners are, including your spouse and family members.
  7. When you have a business, you have intellectual property – at least copyrights and trademarks, and perhaps trade secrets and patentable ideas. Create an intellectual property strategy to protect these things. This is another time when you should at least buy an hour with a lawyer.
  8. Draft contract templates for documents you will regularly use with vendors and customers. Many business owners get contract templates from the internet. This is an acceptable way to start this project, but you should have a lawyer review them to make sure they are legal and address your needs.
  9. Register your trademark with the USPTO.
  10. If you have employees, you will need employment contracts and an employee handbook that includes a social media policy that complies with the National Labor Relations Act.

Ideally, every new business would have a lawyer to help them set up avoid any legal missteps, but many entrepreneurs can’t afford it. There are a lot of things you can do without a lawyer’s help, but you need to be well-informed about what your’e required to do when going into business for yourself and when it’s worth it to pay for a lawyer (like me).

It’s much easier and cheaper in the long run to consult a lawyer a few times when you’re starting your business than to have to hire one to clean up the mess that can result if you do it the wrong way.

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Why You Need an Operating Agreement

Sailor race cardboard boat in base competition by Official U.S. Navy Imagery

If you have an LLC and your company has more than one owner, you need an operating agreement. Period.

An operating agreement is a contract between the owners of a business that tells them how they’re going to run their business. Think of it as the owners’ rule book and prenuptial agreement. It puts everyone on the same page from the beginning in terms of what each person owns, what each person is responsible for, and how you’re going to resolve problems.

Your operating agreement can answer important questions like:

  • If an owner wants out, how much notice does he have to give? Do the other owners have first dibs on buying his portion of the company?
  • Do owners ever have to contribute their own money to the business?
  • What do you do if an owner isn’t pulling her weight? Can she be voted out of the company?
  • How will disputes be settled? If there’s an even number of owners with equal votes on each side, what’s the tie-breaker?
  • What happens if an owner dies?

Don’t think that you don’t have to create an operating agreement if you’re going into business with your best friend, spouse, or relative. We all know someone who has gone through a nasty divorce. The same can happen in the break up of a business if there isn’t an operating agreement that tells you how events will proceed.

It may seem strange to think about how you’ll handle problems at the beginning of the business, but it’s the ideal time to put these provisions into place. Hopefully everyone is optimistic and thinking about the business’ best interests which will make it easier to decide the best way to handle major decisions down the road. If you put off figuring out how you’ll resolve disputes until one occurs, you’ll be fighting over how the company should resolve its problems and you’ll be fighting over the problem at hand.

Operating agreements aren’t just about resolving problems. They give you the ability to create the company you want. Some companies may decide disputes in mediation, but you can choose to settle problems with a coin flip, a game of ping pong, or let your dog decide if that’s what you and the other owners want. You can also use your operating agreement to declare other rules like requiring everyone to bring pie to work on March 14th (Pi Day) and allowing video games as an acceptable brainstorming technique.

You’re not required to have an operating agreement if your LLC is in Arizona, but you’re asking for trouble if you don’t. This is one of those times when it’s worth it to pay a lawyer. You will pay a lot less to have someone draft the agreement for you, than to clean up the mess that could result when you and the other owners have a major dispute and everything goes to hell.