Is A Transfer on Death Designation Right for your Small Business?

May 23, 2018

Many Ohio business ownership interests are eligible for transfer on death (“TOD”) beneficiary designations. Ohio law allows for a business owner to make a simple probate-avoiding estate plan by way of a TOD designation on “securities”, such as membership interests in a limited liability company or stock in a corporation.  It is one of the simplest estate and succession planning techniques out there, but you should carefully consider your intended result before making your business ownership TOD.

Why?  A TOD designation for a small business owner allows the business’s ownership to transfer smoothly and quickly upon an owner’s death.  This avoids the need for probate.  Where a business has a few active owners, a TOD to a loved one, paired with a buy-sell agreement requiring the surviving partners to buy-out the loved one’s inherited interest, may be effective.

Why not?  Your business’s buy-sell agreement, operating agreement, franchise agreement, close corporation agreement, or other controlling documents may prohibit TOD designations.  Where permitted, a TOD designation may be subject to approval by a board. 

A TOD designation may not be appropriate for transfers between unrelated business partners.  A TOD designation is a form of inheritance (gift upon your death).  That means, your TOD beneficiary will receive the business ownership for free and will not pay your family, estate, or other heirs any compensation for the business interest.  So, for example, if it is your intent that your business partner buy-out your share of the business, your business partner should not be your TOD beneficiary.  However, where the TOD is to your family member, and a carefully drafted buy-sell agreement allows the other partners to buy-out your family member, a TOD can be a simple and effective probate-avoidance technique. 

Many professional service businesses cannot be owned by unlicensed individuals.  So, for example, a TOD designation is not an appropriate way to transfer the interest to a family member who is not a licensed member of the profession.

Your TOD beneficiary will own the business interest outright, and may have rights to immediately sell the business interest.  So, if your hope is that the beneficiary retain the business ownership for a period of time, then a TOD designation will not achieve your goal.

A TOD designation is not a replacement for a carefully-drafted will. 

While a TOD designation is a great tool for the succession of some small businesses, most businesses should consider other forms of estate and succession planning.  Consult a legal professional before designating a transfer on death beneficiary for your business.

 

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