Protecting shares in a private company involves planning. Many business owners are so caught up in protecting their company from day-to-day business challenges, such as third-party price competition or meeting commercial contract deadlines, that they do not take corporate and estate planning legal advice on how to protect the business in the event of a shareholder’s death.
In this article, our corporate and estate planning solicitors look at what happens when a shareholder in an owner-managed business dies and how directors and shareholders in private companies can protect the company through proactive corporate and estate planning.
What Happens to Shares When a Shareholder Dies
If a shareholder dies their estate, including their shares, passes under the terms of their Will. If the deceased did not leave a Will the shares and estate pass by intestacy rules. That is fine if the shares are in a PLC but it can be very damaging and disruptive to the remaining shareholders in an owner-managed business and also to the company and its employees.
Shareholders in owner-managed businesses normally pick their business partners and fellow shareholders with care knowing that the success of their business venture rests on a shared vision for the company and the ability of the shareholders to work together for the benefit of the company.
What shareholders do not expect or want to do is to work with someone who may have no experience in business or the sector and who is not a team player or quick learner. These issues can be avoided by forward-thinking estate planning by business owners and shareholders in SMEs.
Right of First Refusal
If asked, the shareholders of a non-listed company would normally want the company or the remaining shareholders to have a right of first refusal to purchase shares if one of their fellow shareholders dies. The family of the deceased shareholder can be protected by including details in the shareholder agreement on:
- Rights of pre-emption so the deceased’s shares must be offered to the remaining shareholders or the company before they can pass to anyone else
- How the shares will be valued. For example, through the use of a predetermined formula or the instruction of an independent accountant to value the shares
- The timescale within which the company or remaining shareholders must exercise their right to purchase the shares
Shareholder Agreements
If on incorporation a company adopts standard articles of association and does not cover the potential for a shareholder to die in the drafting of their shareholder agreement, they increase the risk of disputes and litigation if one of their shareholders passes away. Not only could the remaining shareholders be unable to work with the person who inherited the deceased’s shares, but the deceased’s Will could be challenged by family members or the deceased may have left their estate to a charity whose focus is on realising cash as quickly as possible.
Many of the risks associated with shareholders’ shares falling into the wrong hands on death can be resolved by drawing up bespoke articles of association and/or a shareholder agreement to set out the procedure to be followed if a business owner or director dies.
If an owner-managed business is established, a corporate solicitor can review the existing articles and shareholder agreement and recommend changes that would work for all the shareholders. It is in all the shareholders’ interests to have a quick and practical recorded resolution procedure in case one of them should pass away.
Cross Option Agreements
A company may also want to look at a cross-option agreement granting the business owners options on their shares. These options do not come into effect until a shareholder’s death. If the cross-option is exercised, it means that:
- The deceased business owner’s executors or personal representatives can require the surviving shareholders to buy the deceased’s shares using the formula set out in the cross-option agreement or
- The remaining shareholders can require the executors or personal representatives to sell the deceased’s shares to them under the terms of the cross-option agreement
Life Insurance and Key Person Insurance
Shareholder and cross-option agreements should be considered in conjunction with bespoke insurance with a policy that works for the benefit of the deceased’s family and the company. For example, a specialist life insurance policy may enable the surviving shareholders to be able to easily raise the funds required to purchase the deceased’s shares.
Key person insurance insures against the financial loss a business may suffer if a key person, such as a shareholder or director, passes away. For example, if a shareholder or director dies it may result in the need for the company to hire consultant services or locum managers to keep the company afloat whilst it comes to terms with the loss of a key member. The insurance policy, payable by the company, helps the SME if the business would be heavily impacted by the death of an individual.
Estate Planning for Business Owners
Business owners owe it to their fellow business partners and to their families to have their corporate paperwork in order, combined with efficient estate planning, to protect their fellow shareholders and their family or loved ones.
In addition, it is crucial to consider whether Business Property Relief would apply for inheritance tax purposes. This valuable relief could mean the business passes inheritance tax free to the intended beneficiaries.
Proper estate planning could reduce the risk of commercial litigation, any adverse tax consequences on the business and shareholder disputes if a shareholder dies. The individual shareholders protect their families in the event of their deaths, with a clear and agreed mechanism for their beneficiaries to either join the business or extract the market value for the shares in an orderly fashion and without damaging the business.
How Can Morr & Co Help
If you would like to find out more about corporate estate planning, speak to our team today.
Contact us today on 01737 854 500 or email [email protected] to make an appointment to find out more.