The death of a shareholder can result in significant complications for any business. Planning to protect against those complications offers a real advantage to the remaining shareholders of the company and the business itself, as well as the beneficiaries of the deceased shareholder. It can also help to mitigate the tax position for the estate. This article will leave you better informed about the key issues and what we can help you to do now to plan for the future.
Who should inherit the shares?
On the death of a shareholder, any shares they own will pass to their estate. These shares are considered assets to be distributed in accordance with the shareholder’s will and testament, or intestacy rules if they have not left a will.
The first issue is that the deceased shareholder might not have thought carefully about whether or not their chosen beneficiary will want to inherit the shares. Assets including shares often pass to the children, or the partner of the deceased shareholder. They may have had no previous involvement with the business and its operations; they may have little to no business experience; or they may simply not wish to get involved in the business. There is no statutory requirement that a beneficiary must sell their shares to the existing shareholders, which potentially results in new shareholder(s) that do not subscribe to the existing business plan or vision.
The second issue is, once a suitable beneficiary has been chosen, whether the shares can actually be transferred to them under the articles of association of the company and any shareholders’ agreement. The provisions set out in those documents could prevent the transfer of shares to the chosen beneficiary. They could also prevent cross-options from working correctly (see below for further explanation of cross-options). Avoiding such issues requires careful consideration of the company’s articles and any shareholders’ agreement.
What if the shareholder wants their beneficiaries to realise the value of the shares on death, rather than inherit the shares?
Even if the existing shareholders want to purchase a beneficiary’s shares and the beneficiary is willing to sell, the existing shareholders may not, financially, be able to afford to buy the shares. Equally, there is no statutory requirement that the existing shareholders must purchase shares from a beneficiary, which may result in a beneficiary forced to hold shares, rather than quickly realise a valuable asset.
One solution is to put in place a life policy on the shareholder’s life for the benefit of the other shareholders of the company. This is supported by a cross-option agreement and a letter of wishes to accompany an existing will and testament.
The shareholder enters into a cross-option agreement which, on their death:
a) gives the other shareholders the option to require the deceased’s personal representative(s) to sell the deceased’s shares and interest in the business to the remaining shareholders;
b) allows the deceased’s personal representatives to require the existing shareholders to purchase the deceased’s shares and interest in the business; and
c) sets a time scale on the completion process once an option has been exercised.
The life policy is intended to provide funding to enable the cross-options to operate effectively. It ensures the shareholders receive adequate funds to purchase the deceased’s shares should they be required or wish to do so.
The value of the life policy will reflect the value of the shareholder’s stake in the business. This will fluctuate and so payment can be linked to the proceeds of the relevant policy or a fixed amount. Either way, this is normally reviewed periodically under the terms of the cross-option agreement.
Letter of wishes
A letter of wishes is best practice to sit alongside the will and testament of a shareholder. This ensures a deceased’s personal representative is made aware of the cross-options and their ability to insist on the purchase of the shares (as the remaining shareholders will have received the insurance funds for that purpose).
Business Property Relief
You may be wondering why an option is used rather than a positive obligation on the existing shareholders to purchase the deceased’s shares and, predictably, the answer is because of the tax advantage this can create.
Where a cross-option is carefully and correctly drafted, it does not represent a binding contract for the sale and purchase of shares in the event of a shareholder’s death, it provides either party with the option to require sale/purchase. This allows the share sale/purchase to benefit from business property relief. The beneficiaries of the deceased’s estate then receive the value of the share sale in a tax efficient manner and the existing shareholders can complete the share purchase without significant financial burden.
A life policy and cross-option provide a tax efficient method of protecting your business against the death of a shareholder. They provide financial and business security for the remaining shareholders whilst protecting the value of the shares gifted to beneficiaries.
1. Decide what you want to happen to your shares on death and make sure this is reflected in an up-to-date will.
2. If necessary, put in place a cross-option agreement and appropriate life insurance.
3. Review articles of association and any relevant shareholders’ agreements to make sure they allow the transfers envisaged.
Our team of experts can guide you through each of these steps. For more detailed advice contact Jenny Chatten.
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