There are more than four million limited companies registered in the UK.
About 500,000 more are incorporated every year, according to Companies House.
Every company is reliant on those at the top to steer the ship and keep the business profitable.
But what happens if one of those shareholders suddenly dies or becomes too ill to continue in the business?
Apart from the obvious personal tragedy, it creates a serious and clear threat to the business’ future, especially when it comes to future leadership and what happens to the shares of the deceased.
Many businesses aren’t prepared for the consequences of the sudden loss of a shareholder.
And this creates a real financial risk, as well as puts the future direction of the company in jeopardy.
One of the easiest solutions is to invest in shareholder protection insurance.
This death in service benefit can provide financial reassurance that the funds will be available to buy back any outgoing shares to keep control of the business with the remaining shareholders.
It also provides the deceased shareholder’s family a guarantee that they’ll receive fair value for the shares.
But what would happen if a business lost a shareholder to death or illness, and they didn’t have shareholder protection in place?
Let’s look…
What happens to a deceased person’s shares in the event of a death?
Any company incorporated after the Companies Act 2006 will largely be governed by the rules laid out in the legislation when it comes to the distribution and devolution of shares in the event of a death.
Under the Companies Act 2006, let’s imagine that three shareholders each have equal shares in the company from the day it’s created.
One of these shareholders dies and has gifted their shares in the company to their estate via a Will.
There’s no obligation for the recipient of the shares to sell them back to the remaining shareholders.
They could become a part of the business, even if they have no experience.
In another scenario, the deceased’s estate might be willing to sell the shares to the remaining shareholders, but they don’t have the funds available.
Or, taking funds out of the business to purchase the shares could put the long-term viability of the company at risk.
The deceased’s estate could choose to keep hold of the shares if the company can’t afford to buy them, and continue to benefit from them financially – even though they have no involvement in the running of the company.
But they could also decide to sell their shares on the open market.
They could even sell them to a competitor or a third party whose vision for the company conflicts with the remaining shareholders.
This now puts the company’s immediate and long-term future at risk.
It also risks the deceased shareholders not getting a fair value for the shares if they do sell them to a third party.
What if your articles of association dictate what happens to the shares?
Every company must submit articles of association, which could include a clause for the distribution of shares in the event of a death.
But this still leaves the financial issue.
No shareholder is realistically going to agree to hand back shares in their business with no guarantee their estate will receive fair value for them.
So this still relies on the company having the available funds on hand to buy the shares.
Now you might have a fund available to cover the costs of the shares when you first start.
But what if the company has grown in the period since the articles of association were submitted, and those shares are worth substantially more than the initial money put aside?
You have the same problem again.
The business can’t afford to buy the shares, without putting its own viability at risk.
So the deceased’s estate can keep the shares and claim a dividend, or sell them.
Can’t we use a bank loan to cover the costs?
Typically speaking you’ll find it incredibly difficult to find a bank willing to issue a business loan for the buyback of a deceased’s shareholders shares in a company.
The bank will want reassurance they’ll get their money back and, given that the death of a shareholder is one of the main contributing factors of a business failing, there are few guarantees that can be made that the loan will be paid back.
This becomes even less likely if the deceased shareholder is deemed to have been the main profit driver in the company.
Can’t we create a cross-option agreement?
A cross-option agreement creates a guaranteed right (but no legal obligation) for either party to force the sale or purchase of a deceased person’s shares before they’re transferred to another party.
A cross-option agreement is usually subject to two possible scenarios:
- Call option: Gives the remaining shareholder the right (but no obligation) to buy the shares
- Put option: Gives the deceased shareholder’s estate the right (but no obligation) to require the remaining shareholders purchase the shares
But again, this doesn’t get around the financial aspect.
Just because the remaining shareholders wish to activate a call option, doesn’t mean they’ll have the funds available within the business to buy them.
Or at least not to buy them and for the business to remain on a stable financial footing.
On the other hand, the deceased’s estate might decide to force the purchase of the shares by the remaining shareholders.
At this point, they have to find the money to buy the shares, and this could put the business at serious risk.
So how does shareholder protection insurance help?
Simply, shareholder protection insurance ensures the finances are in place for the purchase of any shares left by a deceased shareholder.
The policy itself can either be taken out and paid for by the individual shareholders.
Or it can be owned and paid for by the business.
Either way, it will guarantee a payout that allows remaining shareholders to retain control of the shares, and ensure the deceased’s estate gets the fair value.
From a business perspective, it allows for the smooth transition of shares and controls back into the company so it can weather the storm of losing a shareholder, without threatening its financial position.
It also protects the shareholders from losing control of their business to an unwanted third party.
Typically, shareholder protection insurance will be combined with a cross option agreement or clauses in the articles of association so the transfer of shares is a smooth process.
Business protection for a worst-case scenario
Losing a shareholder to sudden death isn’t something anyone wants to think about.
But it’s always a possibility and from a business perspective, it’s the responsibility of the shareholders to ensure the company can survive any unforeseen circumstance, regardless of how personally tragic it might be.
With shareholder protection in place, all parties can be assured that the transfer of shares, and the payments, will be a smooth process.
The alternative is a complicated, drawn-out, and expensive proposition that can put any company at serious risk of collapse.
