It’s understandable that talk of death and illness can be a sensitive and unpleasant topic but for SME’s whose owners also work full time in the business, critical illness or death of a shareholder must be provided for.
Share transfer provisions
Any company with two or more shareholders should have a shareholders’ agreement in place. One of the key clauses in a shareholders’ agreement (or the articles of association) deals with the share transfer provisions during life of the shareholders and share transfers on their death or critical illness.
Shareholders need to agree how and when shares can be transferred, to whom and whether any price discounts should be applied on a sale. In the absence of any agreement it is likely that on the death of a shareholder, their assets will pass pursuant to the terms of their will or pursuant to the intestacy rules if no will has been made. This could leave the surviving shareholder or shareholders running a business whilst having a business partner who is not also working in the business.
Shareholders should therefore plan for the event of the death of a working shareholder and decide whether the surviving shareholders or the company should have a right of first refusal to purchase the deceased’s shares and if so, the terms of such share purchase.
To preserve Business Property Relief there should not be a binding contract for sale of shares in place arising on the death of a shareholder. To preserve this relief a cross-option agreement is often put in place to give the deceased’s estate an option to sell the shares back to the surviving shareholder and for the surviving shareholder or shareholders to have the option to purchase.
Funding a purchase
Even where a shareholders’ agreement provides for pre-emption rights on a transfer of shares and/or a cross option agreement is in place, the issue of funding could still prove a problem. If the company or the surviving shareholder(s) does not have the money to pay for the deceased’s shareholder’s shares, this could delay a purchase and cause problems at management level.
One way to counter this potential problem is for the owners of the company to take out life and or critical illness insurance policies against their lives, the proceeds of which can be used to fund a share purchase. Life insurance policies, if available, can provide the requisite funding to ensure the deceased’s estate receive value for the deceased’s shares and the ongoing shareholder(s) or the company can recover full control of a company without having to fund an unexpected share purchase.
A critical illness insurance policy allows a company to continue to pay a shareholder if they are unable to work as a result of a serious illness. Key person insurance cover can also be taken out to cover the costs of replacing the shareholder’s job role for a shareholder who is unable to work in the business.
Insurance brokers or financial advisors are best placed to advise on the terms of available policies but if insurances are put in place it is imperative to ensure they are reflected in the shareholders' agreement or articles of association so that there are no loose ends.
The terms outlined in a shareholders’ agreement should always be properly documented and reviewed regularly, this will help to avoid disputes and any further distress that already comes with a death or critical diagnosis.
If you require help or advice regarding a company’s shareholder’s agreement, or simply need to find out more, don’t hesitate to contact our Bristol solicitors on 0117 9733989 or fill out a contact form.