Entrepreneur’s will, part II: What should you bear in mind when drawing up an entrepreneur’s will? 

For business owners or shareholders, it is almost essential to draw up an entrepreneur’s will. But what else do you need to know and consider when it comes to entrepreneur’s wills and succession planning?

What should be included in an entrepreneur’s will?

It is important to bear in mind that there is no one universally correct content for an entrepreneur’s will.
Too many individual circumstances are decisive for finding the right arrangements for a specific company succession in the event of death: Is it an actively managed family business or merely a shareholding? Are several family branches/shareholders involved? Is there one or more successors within the family? Should someone outside the family take over? How much private wealth is available to potentially ensure fairness within the family? What are the wishes of the entrepreneur and their family or any third parties involved? In this respect, individual, professional advice and support are essential when drawing up such a will.

In general, there are of course aspects that always need to be considered and regulated when drawing up an entrepreneur’s will, albeit depending on the individual circumstances.

Important points to regulate include, for example:

• Determination of the successor(s) and the specific form of the arrangement in the will (e.g. bequest, division order, sole appointment of heir, etc.),
• Arrangement of legacies, e.g. for the distribution of the remaining estate to so-called ‘departing family members’,
• Protection of departing family members, e.g. through payments from the company’s income (but if structured incorrectly, there is a considerable risk that ‘hidden reserves’ will be uncovered and taxed),
• If necessary, appointment of an executor and definition of their duties and powers – especially in the case of minors who are to take over the company at some point.
• Choice of law for entrepreneurs who live predominantly abroad (Art. 21(1) and Art. 22 of the EU Succession Regulation – EU Succession Regulation).

However, as beneficial as it often is to establish detailed regulations in legal matters, this can also lead to problems in the case of an entrepreneur’s will: excessive restrictions in an entrepreneur’s will can severely limit the future owners’ ability to act. This, too, can have significant negative consequences for the company.

For example, restrictions due to prior and subsequent inheritance or permanent enforcement (in the case of minors, for example) can cause difficulties for the business later on. It is also possible to impose conditions or requirements for taking over the business (e.g. completion of a suitable degree), but this is certainly risky.

Last but not least, a form of will that is popular among married couples can become a pitfall in a business context: the classic Berlin will. Here, spouses initially appoint each other as sole heirs in the event of the death of one spouse, with children becoming heirs of the last surviving spouse. In case of doubt, this prevents a community of heirs consisting of the spouse and children from immediately coming into being with regard to a company upon the death of the entrepreneur.

However, in the event of the first death, this de facto disinheritance of the children means that these children may have claims to a compulsory portion against the surviving spouse. In the worst case scenario, if there are insufficient liquid funds, these claims may result in the company or company shares having to be sold or liquidated.

The ‘classic’ Berlin will is therefore unsuitable as an entrepreneur’s will, but with adjustments (e.g. bequests relating to companies/company shares) it is a conceivable solution. The decisive factor in the design is always the legal form (partnership/corporation) in which the company or business is run.

Company law before inheritance law

Inheritance law and inheritance planning are fundamentally important when it comes to regulating company succession in the event of death. However, inheritance law alone does not determine who will continue to run the company in the event of an entrepreneur’s death – especially in the case of companies organised as partnerships or corporations.

Depending on the legal form of the company that is part of the estate, company law has a decisive influence on whether and how company shares can be transferred via the articles of association.

In practice, partnership agreements often specify exactly what should happen to a partner’s share in the company in the event of their death, e.g. the continuation of the company with the deceased’s share accruing to the remaining partners.

Note: If a shareholder dies and his shares are not transferred to his heirs (by will), the heirs are generally still entitled to compensation for the share of the company that is removed from the estate. There are often (insufficient) provisions for this in the articles of association.

Similarly, the partnership agreement may contain a provision specifying who can become the successor to a (co-)entrepreneur (e.g. only descendants of partners) and who cannot. It may also be stipulated that, for example, the execution of a will in relation to the company share is prohibited. The latter then prevents, for example, the appointment of minors as company successors under the execution of a will.

Please note: In practice, this disregarded conflict between succession and the articles of association often leads to the shares/rights of minors having to be managed/exercised by (several) supplementary guardians. However, the focus of a supplementary guardian is primarily on the interests of the child (in particular, avoiding risks) and not on the interests of the company, so that their actions may not always be in the interests of the company.

Problems often arise because provisions in the articles of association generally take precedence over provisions in the entrepreneur’s will: individually established company law takes precedence over the entrepreneur’s inheritance provisions. If this is not taken into account when drafting a will, considerable settlement problems usually arise, which can lead to a completely different outcome than intended by the testator and, moreover, can trigger very significant/ruinous tax burdens.

This makes it clear that an entrepreneur’s will cannot be viewed in isolation if the company is organised as a partnership (GbR, KG, OHG, GmbH, GmbH & Co KG, etc.). It is essential that the will and the partnership agreement are precisely coordinated!

Don’t forget your taxes

The inheritance of companies (or shares in companies) is, of course, also a highly tax-relevant process: depending on the tax bracket and family relationship, up to 50% inheritance tax may be levied on the heir. Even if companies (or shares in companies) are transferred to the spouse and/or the next generation in the event of inheritance, up to 30% inheritance tax may be payable. In addition to inheritance tax, other types of tax may also apply if the will and the articles of association are not aligned or if the transaction is not handled correctly, in particular income tax (due to the unwitting disclosure of hidden reserves) or gift tax (even at the level of any co-shareholders).

In the case of inheritance tax, the so-called ‘taxable acquisition’ in relation to the company is generally calculated from the value of the company or the company shares minus estate liabilities, tax exemptions and personal allowances.

The factual tax exemptions are particularly interesting here, because under certain conditions, companies (or shares in companies) are not included in the taxable acquisition. In particular, the exemption provisions in Sections 13a and 13b of the Inheritance and Gift Tax Act (ErbStG) offer significant tax exemptions for business assets – 85% in the case of a standard exemption and as much as 100% in the case of an optional exemption. The amount of the exemption depends in particular on the duration and scope of the continuation of the business, but also on the composition of the business assets.

However, a rule exemption (85%) or option exemption (100%) is only possible under very strict conditions, which have a significant impact on corporate strategy. In the case of an option exemption (100%), for example, the following conditions in particular must be met:

• The seven-year retention period must be observed: The ‘inherited business’ (business assets) may not be abandoned or sold for at least seven years, nor may any significant operating assets be removed. Any subsequent violation of the retention periods constitutes a retroactive event, and the tax will then be levied retrospectively. Violations must be reported to the tax office independently (otherwise possible tax evasion/tax avoidance).

• The company’s annual wage bill may not fall below the initial wage bill (average of the last five years prior to the inheritance) within seven years of the acquisition.

• The company’s so-called (non-productive) administrative assets (e.g. real estate leased to third parties) may not exceed 20% of its operating assets. If the proportion is too high, the exemption may be completely waived.

• In the case of corporations, the deceased’s share in the company must generally exceed 25% or, if it is less than this, a so-called pool agreement must have been concluded with other shareholders during the deceased’s lifetime.

• For acquisitions exceeding 26 million, an additional ‘exemption requirement assessment’ is carried out and, if necessary, the tax exemption is reduced.

If not all requirements are met, the tax exemption will not apply (at least in part). It is also important to note that the requirements for a 100% exemption are understandably higher than those for an 85% exemption.

The same conditions apply to the 85% exemption, but they are somewhat less stringent (e.g. five-year retention period, wage bill regulation only for five years). The purchaser must apply for the relief to be claimed in the course of the inheritance tax return. However, if, for example, the 100% application is submitted but the conditions are not fully met, this does not necessarily result in 85% relief; instead, it is also possible that the relief will be completely waived. The difficulty in making the right decision when submitting the application also lies in the fact that it only becomes clear seven years later whether all the requirements have been met or not (wage bill/retention periods).

The tax relief described above can also be considered for gifts made during the lifetime of the donor. In this respect, a lifetime transfer should also be considered when drawing up an entrepreneur’s will or planning business succession, as this is easier to plan for from a tax perspective (clear date and therefore controllable composition of the operating/administrative assets at that date).

Tip! Tax relief is also particularly important when drawing up an entrepreneur’s will, as care must be taken to ensure that the will does not contain any provisions that conflict with tax relief.

Regularly review your will to ensure it is up to date, powers of attorney are essential, involve your successors

However, it is not enough to simply arrange for the succession of the business in the event of death by means of an entrepreneur’s will. This will should be reviewed regularly to ensure that it is still up to date, especially in conjunction with provisions in the articles of association.

It is also just as important to issue powers of attorney to trusted individuals during your lifetime, which take effect in the event of a long-term or permanent incapacity (entrepreneurial power of attorney) and, as a transmortal power of attorney (valid both during your lifetime and after your death) or postmortal power of attorney (valid only after your death), also bridge the period between your death and the conclusion of the probate proceedings.

Conclusion

Entrepreneurs should address the issue of business succession in the event of death at an early stage with professional support and, where possible, involve planned successors during their lifetime – as well as persons affected by succession arrangements. It is important to bear in mind that inheritance law cannot be considered in isolation: interfaces with company law, tax law and management consulting must also be taken into account, as strategic issues relating to the continuation of the business (including the proportion of administrative assets) can have a significant impact on the future tax burden.

If these aspects are taken into account by an expert, this significantly reduces both the risk of subsequent (inheritance) disputes over the entire estate and, in particular, the risk that

• incorrect tax planning due to lack of liquidity,
• disputes resulting from invalid/unclear provisions and/or
• lack of liquidity due to unconsidered compulsory portion claims

destroy a company.

In part I of this article, you can find out more about

• the risks of statutory succession,
• the importance of clearly regulated company shares,
• the effects of a lack of succession planning and
• the relevance for all types of companies.

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