The Overlooked Business Risk Every Owner Should Plan For - Cognitive Decline

Having recently attended a panel discussion on cases involving cognitive decline and vulnerable adults hosted by our local estate planning council, I came away with a heightened awareness of how many of us are affected at some point in our lives by our own declining mental fitness or that of a family member. Whether the decline is sudden, or gradual, diminished capacity can leave a person vulnerable, and this vulnerability is especially significant for business owners.

As advisors, we encourage clients to plan for the possibility of mental incapacity because cognitive decline is a foreseeable part of aging. Public health agencies such as the Centers for Disease Control and Prevention (CDC) and the National Institutes of Health regularly track data on dementia and cognitive health in the United States. Although estimates vary, research generally suggests that approximately 10% of Americans age 65 and older are living with dementia, and one third have mild cognitive impairment.

First of all, it is important to distinguish between cognitive decline, dementia, and legal incapacity. Cognitive decline is a broad clinical term describing changes in memory, reasoning, judgment or decision-making that may occur gradually over time. Dementia is a more advanced medical condition involving significant cognitive impairment that interferes with daily functioning and independence. Not all cognitive decline progresses to dementia, and a person may experience measurable decline for years before meeting the clinical criteria for dementia or the legal standard for incapacity.

In Michigan, legal incapacity is not determined by a medical diagnosis alone. The legal standard is whether the individual lacks sufficient understanding or capacity to make or communicate informed decisions. As a result, cognitive decline often exists in a gray area where a person may appear competent while struggling with complex financial, operational or strategic decisions. This distinction is critical because vulnerability to poor judgment, exploitation or undue influence frequently emerges long before clear legal incapacity exists.

For business owners, risks are substantially magnified. Closely held business owners often serve as the central decision-maker and repository of institutional knowledge controlling banking relationships, financial accounts, payroll, contracts, tax and customer relationships. In many cases, critical procedures and information exist only in the owner’s mind rather than in formal systems or in documented processes.

As cognitive decline progresses, the owner may become increasingly vulnerable to undue influence, fraud and financial exploitation. Employees and vendors may recognize these vulnerabilities before family members do, and in some cases, may exploit the owner’s declining capacity.

How does the business owner prepare for gradual cognitive decline before it rises to the level of legal incapacity?

Planning should begin well before any signs of impairment appear. Proactive preparation allows the business owner – not a court or a crisis – to determine how business operations will continue if judgment or decision-making becomes impaired. The objective is to establish systems that protect the owner and family, preserve business continuity and value and reduce the risk of exploitation, litigation or disruptive guardianship and conservatorship proceedings.

Effective planning should involve the owner’s core professional advisory team, including a business attorney, estate-planning counsel, CPA, financial advisor, insurance professional and key operations personnel. Business continuity documents should align with the owner’s personal estate-planning documents, such as durable financial power of attorney, patient advocate designation or medical power of attorney, advance directive, HIPAA authorization, last will and testament and revocable living trust.

Governance Documents and Decision-Making Structure

Business owners who want their companies to operate smoothly during periods of cognitive decline should begin by reviewing their existing governance documents, including shareholder agreements, operating agreements, partnership agreements, bylaws and related corporate records. These documents form the legal framework for how the business operates and should clearly define management authority, succession procedures and who may legally bind the company if the owner’s decision-making capacity becomes impaired.

The specific documents required will vary depending on the type of business entity, but well-drafted governance documents help reduce ambiguity and operational disruption during periods of transition. At a minimum, the documents should address banking authority, delegation of operational responsibilities, procedures for determining incapacity, buyout or succession provisions and mechanisms for transferring institutional knowledge to key employees or successors.

Business Continuity Plan

In addition to establishing strong governance documents, business owners should maintain a written continuity plan describing how the business will function during disruptions that will impair or interrupt normal operations. For closely held businesses, this plan should specifically address how authority will work in practice during diminished judgment or gradual cognitive decline. A good continuity plan serves as a roadmap for maintaining contractual performance, preventing fraud or undue influence and transitioning authority in a controlled and documented manner.

Delegation of Authority with Oversight

Business owners may consider implementation of a formal system for delegating operational responsibilities to trusted individuals while maintaining appropriate oversight and accountability. Delegation should clearly define the scope of each person’s authority and may include banking access, vendor contracts, payroll administration, financial management and other essential operational functions necessary to maintain business continuity.

Delegation, however, should be paired with safeguards designed to reduce the risk of error, abuse or financial exploitation. Appropriate protections may include dual-signature requirements for significant transactions, segregation of financial duties, spending limits, periodic reviews by outside accountants, regular reporting obligations and ongoing monitoring of account activity and contracts. Owners should also periodically review and update delegated authority to reflect personnel changes or evolving business needs.

Business owners should be aware that banks and financial institutions often require specific documentation before adding authorized signers or granting account access, including board resolutions, corporate authorizations, signature cards and personal identifiable information for each authorized individual. Internal resolutions and governance documents should clearly identify authorized officers or managers, their titles, the scope and duration of their authority and any limitations on their decision-making powers.

Decentralization

In closely held businesses where the owner may control most aspects of the business, decentralization can further reduce risk. Segregating duties – for example, separating contract negotiation, approval authority, and payment authorization – helps protect the owner from undue influence and from fraud and embezzlement in the company.

Standard Operating Procedures

It is a best practice to formally document critical procedures in writing for activities such as payroll, vendor payments, pricing approvals, compliance requirements and any other task essential to ongoing operations.

Centralized Document Repository

Business owners should consider establishing a secure physical or electronic repository for critical organizational records and clearly define who should have access to them. Important documents may include customer contracts, insurance policies, leases, tax returns and essential corporate records.

Business Password Management Systems

Business operations can quickly be disrupted if critical system passwords are known only by the owner. Owners should establish a digital access and continuity plan that identifies essential systems and clearly designates who is authorized to access them. A centralized enterprise password manager is one of the most effective safeguards, supported by a primary and back up administrator with defined recovery roles. Whenever possible, authentication should be tied to company-controlled systems rather than the owner’s personal device or biometric credentials to ensure continuity and reduce operational risk.

Independent Oversight

Business owners may also benefit from independent oversight, such as an annual CPA review, establishment of an internal audit committee, or implementation of an advisory committee or board. These structures help detect irregular transactions or operational concerns, especially when the owner exercises broad control. They may also strengthen the company’s position with lenders, insurers and other outside stakeholders.

Buy/Sell Agreements

If the business has multiple owners, or key employees are already involved in operations, a buy/sell agreement may be an important planning tool. This document will outline triggering events for purchase rights, valuation method, voting control and the exit mechanics. This strategy is particularly useful when continuity and preservation of the business are top priorities.

Rely on Trusted Advisors

Business owners should regularly engage their trusted advisors – such as CPAs, attorneys, financial advisors and insurance professionals – to help guide important business decisions and reduce the risk of costly mistakes. Each advisor brings a distinct perspective on tax implications, legal exposure, financial structure and risk management that can be difficult for a single decision-maker to fully evaluate alone. Involving a coordinated advisory team helps ensure decisions are well-informed, properly documented to support business continuity and protection goals.

In closing, no business owner expects cognitive decline to factor into risk management, but it is a real possibility that can affect any family or business. Proactive steps taken early can help reduce the risk of exploitation, and protect the owner and their family, as well as employees and customers who rely on them.