All businesses should have a succession plan in place but many do not. But what will happen to the business if anything happens to the owner or if misfortune befalls other shareholders or partners? What would you like to happen?
- The shares pass to the heirs – would you have the heirs as partners?
- The shares pass to you – but what of the claims by the heirs?
- The shares pass to management and/or employees – but what of your heirs if you are the one who died?
- The business buys back the shares – but where will the funds come from?
- The business is sold – but most likely with a loss in value.
- The shares pass to the surviving shareholders/partners, with cash paid to heirs.
Shares in unquoted companies are generally unmarketable and more so if a principal passes away.
But what if one of the shareholders working in the company wishes to retire or withdraw. How will that be dealt with? Dealing with difficult issues at a time of turmoil and high emotion is not recommended.
A shareholders agreement negotiated and agreed at a time of stability is therefore recommended and its importance cannot be over emphasized.
A shareholders agreement should address important issues such as;
- What happens to the shares upon death or incapacity of a shareholder?
- What will happen if a shareholder wishes to retire or withdraw?
- What happens if the relationship breaks down and there is a wish for a parting of the way?
- How is the value of the company to be determined? Do not fix a value, just the method to be used
- How is a purchase of shares to be funded?
There may be other areas that the shareholders wish to include but these are the basics. A good shareholders agreement will have as its base a buy and sell agreement. This will also help with inheritance tax in that it is a binding contract of sale where the parties must act and exchange shares for cash. It is mandatory on the happening of a certain event such as death and is not flexible.
A double option agreement is one for sale after death and may happen if the option from either side to purchase the share is activated. Consequently any available business property relief in respect of shares should be preserved for IHT purposes.
Valuing a business is a complex affair with often accountants doing the valuation. However as there are so many methods to use it is best that a method is decided beforehand which may or may not include goodwill of the business. It binds the remaining shareholders and any heirs to a value which can be calculated without it descending into an argument.
Funding of the buying of the shares, be it the company or remaining shareholders, can be by an insurance policy which can be paid for by the company without attracting a benefit in kind, if properly constructed.
We have referred to shareholders agreements but they also apply to partnership, real or implied. Partnerships are even more vulnerable. On the death of a partner, in the absence of any agreements, the 1890 Partnership Act takes over by default. This means the heirs of a deceased partner have an immediate call for cash for the value of the deceased partner’s share.
A good shareholders/partnership agreement will ensure the continuance of the business after a traumatic even like a death of a shareholder but will also provide for the heirs in a tax effective manner and give some financial comfort.
If you have an agreement check it is still relevant and update as necessary.
Should you wish further guidance do contact Richard Terhorst on Richard.firstname.lastname@example.org or phone 0782 729 3651