A sole proprietorship is a type of business organization that has a single owner. This type of organization is popular due to how easy and comparatively cheap it is to form. The sole proprietor is personally responsible for the business’s liabilities, so if the business lacks the resources to settle its debts, the owner must pay off the liabilities using his personal assets. When a sole proprietor dies, the business usually terminates as well, since a sole proprietorship is so closely tied to its owner. However, if the sole proprietor carefully plans his estate, his business can survive in some form after his death, either in the hands of his heirs or through a third-party purchaser.
Liquidation of a sole proprietorship is the process of selling business assets to individuals. The assets of a sole proprietorship are generally considered probate property, so the sale of these items will have to go through the probate process. Since the probate process can be quite lengthy, it may be a while before the decedent’s heirs get their share of the sale of the asset. The estate may also not receive full market price for the proprietorship’s assets, since it is trying to sell everything quickly. Finally, since the proprietorship’s assets are included in the owner’s estate, the owner’s creditors may claim proceeds from the sale of the proprietorship's assets to settle the owner’s personal and business debts.
Transfer to Heirs
Another option is for a decedent's heirs to take over the business, which poses some challenges. If the business is transferred after the original sole proprietor dies, all of the business’s assets must still pass through probate. To protect the business’s assets from creditor claims, the new owners of the business may have to settle the outstanding debts. Settling debts and restarting the business may require significant amounts of money the new owners do not have. In addition, the new owners must create a new business since a sole proprietorship is non-transferable. Therefore, the new owners would need to create a new business then transfer all of the former proprietorship’s assets into that organization.
Life Insurance and New Heir Owners
If the owner wants to transfer his business to family, he may consider taking out a life insurance policy on himself. The proceeds from a life insurance policy can be used to settle all of his and the business’s debts so the business’s assets are protected. The policy proceeds could also provide capital for the new owners to help restart the business. An additional benefit is that the proceeds from life insurance are exempt from probate, so the beneficiaries of the policy can receive the benefits relatively quickly.
Business Sale to Third Party
Another option is selling the business to a third party. Depending on the size of the business and the timing of the sale, a third party may be unable to purchase the business outright with a lump sum. If the purchaser needs to borrow money to buy the business, the interest expense may make the transaction impossible. If the purchaser decides to purchase the business through an installment plan, the deceased’s beneficiaries may have to wait for a prolonged period to receive the funds.
If the owner wants to sell the business to a third party, he can execute a buy-sell agreement. Otherwise known as a business continuation agreement, the buyer and proprietor agree to the sale of the business prior to the proprietor’s death. The buyer takes out a policy on the proprietor for the agreed price of the business. When the proprietor dies, the buyer uses the proceeds of the policy to pay the full price for the business to the proprietor’s heirs.
John Cromwell specializes in financial, legal and small business issues. Cromwell holds a bachelor's and master's degree in accounting, as well as a Juris Doctor. He is currently a co-founder of two businesses.