1. Know the options available to protect shares if a shareholder dies
There are several legal ways to ensure shares are handled in a way that protects each shareholder’s position and the ongoing success of your business.
However, it may help to have a broad understanding of the options available.
Compulsory transfer
- Compulsory transfer is an effective way to keep shares within an existing shareholder pool. This Is a clause, usually in place in a shareholders’ agreement, which forces the sale of shares to the existing shareholders if an event is triggered.
- For the purposes of this article, we are talking about the death of a shareholder, but it’s worth being aware that other trigger events could include a shareholder leaving the company, retiring, or becoming bankrupt.
- The agreement can cover such details such as how the deceased’s shares should be split – for example offered equally between the remaining shareholders, or weighted according to the size of their existing share.
- It can also specify how much the shares should be sold for – for example at market value, or at a nominal value agreed between the parties.
Pre-emption rights
- Pre-emption rights are effectively a provision that the shares must be offered to the remaining shareholders before they can be sold elsewhere.
- They give the existing shareholder pool the first right of refusal on any transfer of shares – which could extend to cover transfer upon the death of a shareholder. They could also state that the company itself has the option of buying back shares, if it has sufficient funds.
- The use of pre-emption rights limits the opportunity for a third party shareholder (for example a family member of the deceased) to become involved in the company.
- However, if the shareholders or the business decide not to buy the shares, then the beneficiaries become the shareholders and have all the rights attached to them, including the payment of dividends and any voting rights.
Both compulsory transfer and pre-emption rights are important ways to protect shareholders who want to keep the business among themselves without the unwelcome involvement of others. This may be especially important in family businesses where there is a desire to keep it within the existing family pool, restricting which third parties may acquire shares in the company by transfer or inheritance.
2. Consider cross option agreements, and “put and call” options
Cross option agreements are a measure put in place mainly to protect the family or other beneficiaries of the deceased shareholder.
They give assurance that a deceased shareholders’ family will receive value for the shares. Also, like compulsory transfer and pre-emption rights, they provide certainty for the surviving shareholders that they won’t end up in business with the beneficiaries of the deceased shareholder’s estate.
To maintain the availability of Business Property Relief, but to give all parties certainty that the shares can be bought and sold in the way intended, “put and call options” can be used:
- A ‘put’ option allows the deceased shareholders’ personal representatives to require the surviving shareholders (or the company in some circumstances) to buy the shares.
- A ‘call’ option requires the personal representatives of the deceased shareholder to sell the shares to the existing shareholders (or the company in some circumstances).
3. Get insured:
To prepare for the possibility of put and call options being in place, companies often have a life insurance policy for shareholders, known as “key person” or “shareholder protection” insurance, linked to the value of the company in place. This can provide the funds for a purchase if one is required – and can make all the difference between shares being retained in the existing pool, or a business being exposed to the often unwanted involvement of third parties.
It’s worth noting here that key person insurance can also be helpful with other financial pressures that may result from the loss of a shareholder, including the need to hire consultants or others to help keep the company running in the immediate aftermath of their death.
4. Be mindful of inheritance tax
As with any asset being passed on upon the death of its owner, the recipient of shares can be liable for inheritance tax (IHT). It is important to draft agreements with the complexities of IHT in mind, to ensure any transfers take place in the most tax-efficient way.
Broadly speaking, it is important to ensure that any provisions dealing with shares post-death do not require the shares to be transferred, but are written so as to be optional – otherwise Business Property Relief for IHT purposes may not be available.
Cross option agreements can be written in a way which protects the Business Property Relief from inheritance tax which, if available, reduces the value subject to IHT.
5. Beware of reliance on Wills or intestacy rules
If no agreements are drafted within the Articles of Association or shareholders’ agreements, then the general rule is that shares, like any other asset, will be passed on according to the deceased’s will. This gives shareholders less control over what may ultimately happen to those shares, and in most cases is an unsatisfactory way to handle shares for those who remain in the business.
In the absence of a Will or any agreements assets will be distributed, like your personal property, under intestacy rules. This usually means they are passed to the closest surviving relative or, if there are none, to the Crown.
Either way, it is recommended that shareholders do not rely on Wills alone to secure the future of a business.
Thinking ahead about the death of shareholder is a complex and potentially sensitive area, and like so many aspects of business, it is essential to think clearly about what you want to achieve.
If your aim is to restrict shares to the existing pool of shareholders, it is essential to have a well written and thought through shareholders’ agreement and bespoke articles of association to support this. At the same time, tax efficient wills can be prepared which dovetail with the company-specific documents. The
Thrings Corporate Team support businesses of all sizes with comprehensive legal advice on a full range of matters including shareholders agreements.
