While death and taxes may be certain, the former can be more unpredictable than the latter. Ideally, the company’s governing documents include language to deal with the unexpected death of an owner. The owner’s personal estate plan can also impact what happens to their LLC interest upon passing away. But without proper planning, undesirable outcomes—such as dissolution of the business—could occur.
Single-Member LLCs versus Multimember LLCs
All states and the District of Columbia allow for single-member LLCs, which are LLCs with just one owner. According to the Arizona Republic, they are the most popular form of LLC. Single-owner LLCs offer all of the same advantages as multi-owner LLCs. But when it comes to passing on ownership interests, single-member LLCs generally pose fewer complications. An owner of a single-member LLC only has to think about their heirs and the survival of the company. However, owners of a multimember LLC must consider other members’ concerns. These concerns are often addressed in the LLC’s governing documents.
What Do the Governing Documents Say?
LLC members choose to go into business together. Under the default provisions of most states’ LLC statutes, the heir of an LLC member’s interest receives only an economic interest and is not permitted to participate in the management of the LLC unless the LLC’s operating agreement provides for it. New LLC members are typically only admitted in accordance with the procedures specified in the operating agreement, which often include the consent of the surviving members. Surviving members may have no desire to do business with a deceased member’s beneficiary. They can avoid this possibility through a death clause in the operating agreement.
Death clauses can be written to preclude a beneficiary from stepping into the shoes of a deceased member, such as with the following types of provisions:
- A clause stating that the beneficiary of the LLC interest will retain only financial or economic rights in the company and have no management rights. The beneficiary can receive an equitable share of distributions, but will not have voting rights or input in the direction of the company.
- The inclusion of a buy-sell agreement in the governing documents that allows the surviving LLC members to purchase the ownership interests of a deceased member from that member’s beneficiary or
- The dissolution of the LLC if a member dies, and the distribution of that member’s interests to their beneficiaries.
Death clauses can also be used in single-member LLCs to facilitate ownership transfers. For example, the operating agreement could include a transfer-on-death clause that immediately passes the ownership interest to a specified successor at the time of the owner’s death. If this clause is utilized, care should be taken to ensure that it does not conflict with any instructions found in the owner’s estate plan.
If the surviving LLC members welcome the son, daughter, spouse, or other beneficiary of a deceased member as a new business partner, they may still need to amend the operating agreement through a formal vote.
The Consequences of Not Having a Plan
Where LLC governing documents and estate planning documents are silent on the issue of a member’s death, default state laws prevail. Depending on the state, this could mean
- the LLC is automatically dissolved;
- in the case of a single-member LLC, the owner’s heirs are allowed to continue the LLC if they elect to do so within a certain period (g., ninety days in California), otherwise the LLC is dissolved; or
- in multimember LLCs, the deceased member’s estate receives financial or economic rights, but the heirs have no management rights and are at the mercy of the surviving members to make distributions to them.
Plan Ahead and Avoid the Default Rules
Whether you are the sole owner of a single-member LLC or the co-owner of a multimember LLC, the key to avoiding default state rules and their often undesirable business outcomes is planning.
Adding a clause to your operating agreement or including ownership transfer provisions in your governing documents are some of the ways that you can take control of your LLC’s future. Succession planning is best addressed when you initially form your business, but if you neglected succession early on, the next best time to protect your LLC and heirs is right now.
Our business lawyers can help you create a plan that protects what you have spent years building. We can also help heirs understand and protect their rights regarding inherited LLC interests. Contact our office to set up an appointment.