Inherited Businesses

The passing of a business owner is a difficult and tragic event that often comes unexpectedly for their loved ones. Assuming that the business is a part of the decedent’s estate, it is ultimately inherited by an heir (where there is no will) or a named beneficiary in a will or trust. Unless the owner had set up a trust, the estate must go through a probate process under court supervision. Probate may take many months to complete (more if the estate is contested by claimants or creditors). The heirs or beneficiaries of a deceased business owner may keep and operate the business, but often wish to sell when they lack the desire or skill set to operate the business for the long term. When inheriting a business, key steps to take include immediately maintaining its goodwill and operations, securing professional guidance and a business valuation from an experienced business broker, and dealing with the legal and tax implications.

Maintain Business Operations

The unexpected death of a business owner can cause a great amount of instability and chaos, ultimately leading to the dissolution of the business. This is especially the case when the business owner had an instrumental role in its day to day operations. It is essential that the first and most pressing action step necessary after the passing of a business owner is for someone to take charge and bring stability to the business. Issues may immediately arise such as employees not being paid and assured that the business will maintain stable operations. An unstable business environment may lead to the loss of key customers and suppliers, and must be prevented. When going through probate, an executor – typically a close family member – is given the power to make key business decisions and stabilize the business operations.

Legal Authority to Sell Business

So long as the business operations are maintained, the heir or beneficiary of the business will have time to establish legal authority to sell the business. The legal authority involves changing the shareholder or managing member status within the corporate charter and registering the new owner as the officer on sunbiz.org. Until the heir or beneficiary is established as the new legal owner, it is impossible to sell the business. For businesses within an estate going through probate, creditors may file claims against the estate (usually up to one year) for monies owed to them. This can appreciably slow down the process by which the heir or beneficiary may legally establish ownership of the estate (and the business). The quicker that all creditors and other claimants are satisfied, the quicker the sale process of the business may begin.

Value the Inherited Business

When valuing an inherited business, it is crucial to examine the business operations along with the sales and profitability trends after the death of the owner. Many businesses depend to a great extent on the management, relationships, and skills of the owner. So long as the business is stabilized without any affects on its sales and profits, an inherited business is generally valued based on a multiple (typically 2-4 x) of its most recent annual adjusted owner benefit (or true economic profits). If the sales and profits decline after the passing of the owner, then the revised sales and profits should be used for valuation purposes. The goodwill generated by the owner from customer, supplier, and employee relationships must be retained by the inherited business in order for the owner’s goodwill to be included in its valuation.

Example of Selling Inherited Business

Greg has owned and operated a successful plumbing supply business for many years in Palm Beach County.
Without any warning, Greg has passed away intestate (with no will) and has no nearby family members.
Soon after Greg’s passing, his out of state brother, Gene, contacts a local and experienced business broker to figure out the best way to sell the plumbing supply shop.
Gene tells the broker that as the only close living relative of Greg, he has been named the executor by the court to administer Greg’s estate (which includes the business).
The broker highlights the need to maintain continuity in the business by making sure there is a quality manager in place and all employees and vendors are paid.
Gene soon comes to Palm Beach County in order to do so.
Gene also meets with the broker and gives him the most recent financials of the business which show an annual adjusted owner benefit of $400K.
The broker realizes that Gene has promoted a long time employee to manager, and has hired another employee to assume some of the work load.
The extra payroll costs amount to $75K/year.
After the estate passes through probate and Gene is the legal owner, the plumbing supply shop should sell for a multiple based on the revised annual adjusted owner benefit of $325K (deducting the $75K/year for the extra payroll costs necessary to replace Greg’s role in the business).
Since the business is now owned on an absentee-basis, however, the multiple used for valuation purposes will be elevated.
The valuation should thus be about the same as when Greg owned the business, so long as the business is still generating the same level of sales and adjusted profits (not including the extra payroll costs).
It is likely that a buyer will want to verify the up to date sales and adjusted profit levels during formal due diligence, so Gene should be adequately prepared for this eventuality.
Because of the quick action taken in stabilizing the business and installing a manager, the goodwill of the business should remains intact and the business may be sold to a buyer for its fair valuation.

It always best to seek legal and tax advice after inheriting a business. Stabilizing the business and eventually obtaining legal ownership of the business must be accomplished prior to its sale. With sound planning and fortitude, the heirs or beneficiaries of a business may also realize its fair value upon selling.

Give Martin at Five Star Business Brokers of Palm Beach County a call today at 561-827-1181 for a FREE evaluation of your business.