Research published last year by a major UK insurer suggested  that businesses are massively underinsured against a number of  risks. While it is tempting to think “they would say that wouldn’t  they?” some of the statistics highlighted by the research are  interesting. For example, the research found that although nearly  half of business owners thought that if they died their shares would  be acquired by the other shareholders, most of the companies  surveyed had no insurance to meet the cost of doing that and  one third of the respondents had not reviewed their articles of  association since incorporation to check whether the transfer  process would work in the way in which they intended. 

The important point which this raises is that business owners  should not only think about what they want to happen to the  shares of a shareholder who dies but also about whether the  necessary steps have been taken to ensure that this can happen.  If there is conflict between the rights set out in a shareholders  agreement, articles of association or a shareholder’s will, this  may mean that the transfers cannot take place as planned. This  can cause delay and cost and, in the worst case mean that the  shares cannot be transferred as intended. This is particularly  the case where a shareholder dies intestate and the articles and  shareholders agreement are silent on the subject.  

Each business and family will have its own unique circumstances,  but a few general points to consider are as follows. 

  • Protection of family ownership: It is common for articles  of association of a family business  to contain a restriction  on the transfer of shares to non-family members. The exact  way in which this works will vary and needs to be tied in with  provisions in other documents (such as the individual’s wills).
  • Cross options: the transfer of shares can be managed by  including “cross options” in the company’s articles which  provide that if a shareholder dies his shares are automatically  offered to one or more of the other shareholders, who have  a first right to buy them. In this way, the ownership of all of  the shares is kept within the existing circle of owners and the  deceased shareholders’ beneficiaries receive value for their  shares. Where cross options are used;
    • care needs to be taken to ensure that the transfer procedure  is genuinely an option to acquire the shares (rather than a  contractual obligation to acquire the shares) as a binding  contract could jeopardise business property relief on the  shares and trigger a significant charge to inheritance tax.
    • it is important to consider how a purchase by the remaining  shareholders would be funded, because the arrangement  may not be implemented if none of them can afford to  buy the shares. A common approach is for the other  shareholders to take out insurance to meet this cost. If  insurance is used it needs to be reviewed periodically to  ensure that the amount insured reflects the current value  of the shares, and that the beneficiaries of policy are the  right people. It may also be important to consider, from an  accounting and tax perspective who pays the premium (the  company or the shareholders) any consequences of this. 
  • Consistency: whether or not there are cross option  arrangements in the articles, it is important to check that the  provisions of the articles of association are consistent with  other documents, so that for example, shares are not left to  someone in a will only to find that the transfer is prohibited by  the terms of the articles.
  • Other events: shareholders may also want to think about  arrangements in the event of a shareholder being critically  ill or becoming bankrupt and forfeiting his shares as part of  bankruptcy proceedings. In the case of illness it may not be  appropriate for the shareholder to be required to sell their  shares but there may need to be practical arrangements to  ensure that the control of the business can be maintained  effectively (for example it may be helpful to have powers of  attorney in the event that a shareholder is unable to act for a  period of time).
  • Continuity: owners need to think about business continuity  generally. The 2013 research found that nearly half of business  owners thought that their business would be unable to survive  the death or critical illness of a key individual. Even if there  is insurance to allow the other shareholders to acquire the  shares, it is important to consider whether the business is  adequately prepared to survive the upheaval that would follow  an unexpected death or illness. One answer may be using  key person insurance to help the company financially over  any transitional period but there are practical steps which can  be taken too. For example, ensuring that the company has  a properly developed board which can share responsibility,  ensuring business contacts are shared and that there is a plan  to deal with business interruption.
  • Providing liquidity: one way to avoid tensions which can  de-rail a family business is to ensure that family shareholders  who want to realise the value of some or all of their shares  have a way to do so. This can be achieved in different ways (either with the company buying the shares  or other shareholders acquiring them) but it is  important to have a mechanism which is fair  and transparent and (as before) to ensure this  fits in with other share transfer provisions. It is  far easier to agree such a mechanism (including  particularly the approach to valuation) in  advance than to try to do so when relationships  are more fraught. 

It’s not a pleasant subject to think about, but  advance planning of this sort can ensure the  survival of the business and that beneficiaries  receive the value which they deserve. It can also  mean that current shareholders can sleep more  easily at night.