ROBS Succession Planning: How the Company Can Survive the Death of a Co-Owner
See our prior blog post “Protect Your Investment From Disruption by Death, Disability, Divorce & Partner Disputes” for an introduction to the topic and an overview of situations that can cause a ROBS-funded company unexpectedly to find itself partly owned by an outsider.
Every qualified employer retirement plan, including a ROBS plan, must provide a death benefit to a beneficiary, usually a spouse. In the case of a ROBS plan, when one of the owner-participants dies, the assets in the decedent’s account, including the company stock, must be transferred to a new plan account established for the beneficiary. The beneficiary gets to elect the timing and the form of their benefit, from choices laid out in the plan document.
It’s up to the company to select the distribution elections that will be presented in the plan document. The timing provisions can range from no choice at all (requiring only immediate, lump-sum distributions) to various choices such as partial payments made over a period of years, with or without a delayed commencement date. Similar ranges of choices are possible for the form of distribution – from cash only, to “in-kind,” in which the assets are distributed by re-titling them in the name of the beneficiary.
Let’s look at a couple of common plan distribution scenarios that might arise when one ROBS owner dies, leaving a surviving co-owner:
Immediate Liquidation Scenario
Take a look at your plan document. Does it provide death beneficiaries the option to receive a lump-sum, immediate cash distribution (or rollover)? This is very common, and the majority of death beneficiaries are happy to get the benefit immediately and in cash, not surprisingly.
For a ROBS plan, in which the decedent’s plan account is largely made up of company stock, this typical distribution election requires the company to redeem the decedent’s stock for cash and distribute it to the death beneficiary immediately. It starts with a professional appraisal of the company’s fair market value, followed by the company coming up with enough cash to liquidate what may well be a significant percentage of itself, all within a relatively short time frame.
Let’s say you and your best friend start a ROBS company with each of you owning 50% of the company through your plan accounts. If one of you dies, the company will be stuck paying cash equal to 50% of its current value in order just to comply with ERISA, the law which governs retirement plans. Would your company be able to afford that?
To avoid such a potential crisis, a ROBS company with multiple owner-participants should consider buying itself key person life insurance, which is a life insurance policy on certain key people in the company, naming the company as the beneficiary. The amount of coverage could be right-sized to pay for the redemption of the ROBS shares as needed upon the death of one of the owner-participants, thereby smoothing the transition, in a trying time, for both the company and the ROBS beneficiary.
In-Kind Distribution Scenario
In another kind of common situation, the ROBS plan document could give the beneficiary the option to receive an in-kind distribution, i.e., a direct distribution of the company stock. The share certificates formerly naming the plan account as a co-owner would now be re-titled in the name of the widow or other beneficiary. The new co-owner would have certain rights and responsibilities as a shareholder but will not (at least not by virtue of becoming a shareholder in this way) become an employee of the company.
Imagine yourself as a ROBS co-owner—do you know who your co-owner’s death beneficiary is? That person may become your co-owner someday, with or without any understanding of the company and perhaps having no particular interest in the company’s long-term success. It is not hard to imagine that this situation could result in fierce conflicts among old and new shareholders in decisions surrounding board elections and shareholders’ rights.
There is no boilerplate solution to this scenario. But it would be wise, before a death occurs, to ensure that the company knows, understands, and is satisfied with the distribution elections contained in the plan document. Plan amendments can be made if necessary, but only before the death occurs. A plan cannot be retroactively amended to change the form or timing of benefits.
To Sum Up the Important Plan Facts of Life:
The company controls the available distribution options in the plan document;
The beneficiary gets to elect from among the available form and timing options;
The company must implement the beneficiary’s election.
The Bottom Line is: The death of a co-owner in a ROBS-funded business can create financial and ownership challenges. Proactive succession planning—such as reviewing your plan document and considering key person life insurance—can help prevent unexpected disruptions.
Stay ahead of potential risks and protect your investment. Subscribe to ROBSResource.com for expert insights, practical planning strategies, and a community of business owners navigating the same challenges.