The Importance of Shareholder Protection: Safeguarding Your Business Against Death
Please note: This blog is for general information only and does not constitute advice. The information is aimed at retail clients only. You should always seek professional advice from an appropriately qualified adviser.
All contents are based on our understanding of current legislation, which is subject to change, any information provided here is only correct at the time of posting.
The Financial Conduct Authority do not regulate will writing, loans, credit cards or some forms of mortgage, tax advice, offshore investments and estate planning.
For directors and shareholders, the untimely death of a fellow shareholder can cause significant disruption to the business. Beyond the emotional impact, there are practical, financial, and operational issues that arise, which could jeopardise the future of the company.
A report by Legal & General noted that many UK businesses lack adequate protection against key risks, including the death or critical illness of a shareholder. Shareholder protection is often overlooked, despite its critical role in safeguarding business continuity.
Shareholder protection is a solution that aims to provide the business with a lump-sum equal to the value of the deceased’s share, in order to have sufficient cash to pass this value to their estate. It can help to protect the interests of all shareholders, including their family or estate. Here, we explore the main reasons directors and shareholders should prioritise putting shareholder protection in place.
It is important to note that while shareholder protection can be used to protect against critical illness, the focus of this blog post is on protection against death.
1. Maintaining Business Continuity
A sudden loss of a shareholder can destabilise the company’s ownership structure and decision-making process. Without a pre-arranged plan, the deceased shareholder’s shares might pass to their beneficiaries, who may have no interest or experience in running the business. This could lead to disputes, delays in decision-making, or even the sale of the shares to external parties, potentially threatening the company’s stability and long-term strategy.
Shareholder protection provides a clear framework to ensure that shares are retained by existing shareholders or within the business. By pre-arranging how shares will be transferred, directors can safeguard the continuity of operations, enabling the company to function effectively despite unexpected changes in ownership. Typically this would be completed via the articles of association and they may need to be updated to reflect this.
2. Preventing Ownership Disputes
Shareholder protection agreements, such as cross-option agreements, help avoid these disputes by setting out a clear and legally binding process. They allow surviving shareholders to purchase the deceased’s shares at a pre-agreed valuation, providing the beneficiaries with financial compensation while keeping ownership within the company. This reduces the likelihood of conflict and ensures a smooth transition of ownership.
3. Ensuring Financial Stability
The death of a shareholder can place significant financial strain on the company. For instance, the business or remaining shareholders may need to raise funds quickly to buy back the deceased’s shares. Without adequate planning, this could mean taking on expensive loans, dipping into cash reserves, or selling assets, all of which could weaken the company’s financial position.
Shareholder protection involves life insurance policies linked to the agreement, ensuring that the necessary funds are available to purchase the deceased shareholder’s shares. This approach minimises financial disruption and allows the company to focus on maintaining profitability and growth rather than scrambling to raise capital.
4. Protecting the Interests of the Deceased’s Family
From the perspective of the deceased shareholder’s family or estate, inheriting shares can present challenges. While they may benefit from dividends or the eventual sale of the shares, they may not have the expertise, time, or desire to manage or influence the business.
Shareholder protection ensures that the family is fairly compensated for the deceased’s shares, providing them with a lump sum equivalent to their value. This gives them financial security without the complexities of owning or managing shares in a business. It also prevents potential friction between the family and the surviving shareholders.
5. Tax Efficiency
A well-structured shareholder protection plan can help mitigate certain tax implications. For example, the use of cross-option agreements, combined with life insurance policies written in trust, can enable a tax-efficient transfer of shares. The payout from the insurance policy can be used to buy the shares without increasing the taxable value of the deceased’s estate, helping all parties avoid unnecessary tax complications.
How to Implement Shareholder Protection
Setting up shareholder protection involves several key steps:
Drafting Agreements: May require working with your legal professionals to review your business Articles of Association to outline how shares will be transferred in the event of a shareholder’s death.
Valuing Shares: Agree on a method for valuing the shares to ensure fairness and transparency.
Arranging Insurance: Establish life insurance policies for each shareholder, often written in trust, to fund the share purchase. Potentially with the use of cross-option agreements to maximise the tax-efficiency of the plan
Regular Reviews: Periodically review the agreements and insurance policies to ensure they remain relevant as the business evolves and the value of the policies continue to reflect the shareholder value.
Conclusion
For directors and shareholders, putting shareholder protection in place is not just a prudent business decision—it’s an essential safeguard for the company, its stakeholders, and the families of those involved.
By addressing the financial, operational, and personal challenges that arise from the death of a shareholder, this protection ensures the business can continue to thrive while honouring the interests of all parties. Planning for the unexpected might seem daunting, but the peace of mind it provides is invaluable. If you haven’t already considered shareholder protection, now may be the time to act. Your business’s future could depend on it.