If you own a small business that is registered as a limited liability company (LLC), your death or the death of another member of your LLC can introduce stress and a lot of unanswered questions about the future operation of the business. It also can raise legal issues over how the deceased member’s interests in the business are to be administered.
Jump ahead to these sections:
- What Happens to Single-Member LLCs When You Die?
- What Happens If There Are Multiple LLC Owners?
- How Can You Make Sure Your LLC Is in the Right Hands When You Die?
Often, business interests are viewed as assets to be passed on to a business partner’s heirs when they die. But in some cases, the heirs are not equipped to take on the responsibility of the business. Such a dilemma can easily bring a business to a standstill in its operations or may even cause the company to dissolve entirely.
What Happens to Single-Member LLCs When You Die?
If your LLC consists of a single member, that member not only has total interest in the financial success of the business, but that member is solely responsible for managing the business. If that sole member dies, there will be no other members with any authority to continue managing the company or with a financial interest in the company. Therefore most states require that when the sole member of an LLC dies, the LLC shall be dissolved.
It is possible that a sole member may provide for the appointment of new members to take over the ownership and management of the business. However, without such authority being transferred, most states require that the LLC be dissolved.
What Happens If There Are Multiple LLC Owners?
If there are multiple members comprising the LLC, then the operating agreement is a critical tool for defining what happens when a member dies. An operating agreement is a legal document, in essence, a contract between the LLC members that sets out the terms and conditions under which the LLC will operate.
It defines issues such as:
- The capital contributions and ownership percentages of each of the members
- The rights, powers, and obligations of the members, including voting rights and the right to manage the company
- Who owns the company property
- The liabilities of the members
- What happens upon the death, disability, or resignation of a member
- The right of the members to transfer their interests, including upon death
- Conditions under which the LLC will terminate
Not only should the operating agreement identify and define the nature of the deceased member’s interests, but it should clearly describe what interests of the deceased member may be retained by the other members of the LLC. These interests include voting and management rights, in addition to any other interests that can be transferred to family members or legal heirs of the deceased member (such as financial interests).
How Can You Make Sure Your LLC Is in the Right Hands When You Die?
For most LLC companies, the members of the company share in the management, governance, and financial success of the company. When a member of an LLC company dies, the other members work to protect the interests of the deceased member, specifically any financial interests that the deceased member may have in the company that might be transferred to the deceased member’s family. But the surviving members may also want to protect the company and its ability to continue operating with sound management and internal governance.
If all of the interests of a deceased member are transferred to a family member or heir, this may not bode well for the successful continuation of the business. It may put the business in a precarious position if the family member or heir who inherits the deceased member’s management and voting interests does not know how to operate the business.
It is critical, therefore, that the members of the LLC agree upon what interests any member of the LLC may transfer to their heirs upon death and which interests must remain with the company. This agreement should be clearly expressed in the company’s operating agreement.
Execute an operating agreement for the LLC
To best avoid this dilemma when a member of an LLC dies, the LLC members should address the issue of the death of a member in the company’s operating agreement when the business is created. Anticipating the death of LLC members and setting out, in writing, consequences that all members agree upon will clearly define the expectations of the members and inform their families of what will happen to the LLC when one of the members dies.
With regard to the succession of the deceased member’s interests, the operating agreement can provide that the surviving members of the LLC have a right to buy-out the deceased member’s share of the LLC at fair market value before any interests of the deceased member are transferred to the deceased member’s estate.
Even if the LLC is owned by a single member, you should still have an operating agreement detailing how the company will operate and what happens to the company when the sole member dies. The operating agreement might include provisions for taking on future owners upon the death of its member or define the terms of the dissolution of the LLC, including the specific administration of the sole member’s interests upon death.
If you do not have an operating agreement, these issues will be governed by either the deceased member’s estate documents, such as a will or trust, or by the state laws applicable to the LLC.
Make sure the members designate their interests in the LLC in their estate planning documents
If there is no operating agreement, or if the operating agreement is silent about the issue of the succession of a deceased member’s interests, then state law normally will dictate what happens. State laws on this point may vary. Generally, there are three options:
- Dissolution. Some states provide that if a member of an LLC dies and the operating agreement does not provide for succession interests, then the LLC will be dissolved. This means that the LLC will have an opportunity to:
- Conclude any outstanding business
- Collect outstanding assets
- Pay outstanding debts
- Distribute profits and losses among its members
- Estate plan designation. Some states provide that an executor of the deceased member’s estate or the trustee of any trust of the deceased member may govern the deceased member’s interests and negotiate with the LLC how the deceased member’s interests will be administered.
- Intestate succession. If the deceased member has no will or trust, state law provides that the interests of the deceased member will pass to the deceased member’s heirs, through a process called “intestate succession” (“intestate” means that the decedent has no will). Most states provide that if a deceased member’s interests in an LLC are passed to their heirs through intestate succession, only the deceased member’s financial interests, not their voting or management interests in the LLC, will be transferred to their heirs.
Keep in mind that the operating agreement is just a contract between the members of the LLC. So if circumstances warrant it and the members of the LLC agree, the members may amend the operating agreement at any time to address any issues that were not included in the original operating agreement or that require changes.
Executing an Operating Agreement for Your LLC
If a member of an LLC dies, having the issue of succession of a member’s interests in the LLC defined and set out in an operating agreement will clearly define the nature of those interests, how they will be administered, and what effect the member’s death will have on the LLC. Each member, and the families of all the members, will then know with certainty what the interests of each member are and how those interests will be handled upon a member’s death.
Without such clarity in the LLC operating agreement, the succession of the deceased member’s interests — and the very continuation of the LLC — may be left to the application of state law, which usually will either dissolve the LLC altogether or allow the deceased member’s will or trust dictate what happens with their interests in the LLC.