The death of a shareholder can not only be a difficult time for the family, but also for the business itself — especially if the individual is also a director of the company. Building an enterprise and making it a success takes a great deal of effort, often meaning estate planning is pushed down the priority list.
Taking the time to put together a comprehensive business succession plan is crucial to securing the company’s future and your professional legacy. This is because the transfer of a deceased shareholder’s shares can take a great deal of time and be extremely complicated. Without the proper provisions in place, the situation could even result in a dispute between the remaining shareholders or directors.
Preventing this outcome can be achieved by making sure the different types of legal documentation — wills, trusts, articles of association, and shareholders’ agreements — are all in order. This way, the corporate process of dealing with the death of a shareholder can be streamlined and straightforward — thereby removing unnecessary complications from an already stressful time.
What happens to shares after the death of a shareholder?
When a shareholder dies, their shares, along with everything else in their estate, are effectively frozen until probate has been completed and the assets are ready to be distributed amongst the beneficiaries. The estate will be managed by a 'personal representative' (PR), which is either the executor of a will (if one exists) or an administrator. This transferral of company shares is known as a 'transmission'.
What happens next relies on the provisions included in the company’s articles of association and/or shareholders’ agreement, should they exist. If they don’t, deciding who the deceased’s shares should ultimately be transferred to can become extremely complicated to unravel — especially if there isn't a will to fall back on. It is even worse in those circumstances since no one has any say over the deceased’s shares until an administrator has obtained a grant of letters of administration to the deceased person’s estate.
Important documents to consider
The ownership of a deceased shareholder’s shares can ultimately be decided by what’s included in three sets of documentation, namely the last will and testament, and the company’s articles of association and shareholders’ agreements. Having all these provisions in place can make the entire process much more straightforward. Without a will, the shares and other elements of the estate will be distributed according to the laws of intestacy.
Here’s how the three documents are crucial to understanding what happens following the death of a shareholder:
Last Will & Testament
The deceased’s estate will be administered as usual by the executor of the will, who becomes entitled to deal with any shares of the business. This happens automatically and does not require any formal process. However, it doesn’t necessarily mean that the executor can be registered as the new shareholder.
If the executor is also the beneficiary of the shares, those shares will be transferred to them. They can then choose to stay on as the shareholder of the business or sell their shares to a third party. Should a different beneficiary be named, the shares will be transferred to them.
Articles of Association
Alongside a will, a company’s articles of association are one of the first reference points when determining what to do with the shares. All businesses will have one, although many will simply use the same default rules as when the firm was set up. These are known as Model Articles or Table A depending on when the enterprise was formed.
Under the default rules, the person who receives the shares once the deceased’s estate has been administered can either decide to become a shareholder or sell to a third party. Until this decision is made, the individual will be able to receive dividends but cannot vote as a shareholder.
It’s recommended that companies change their articles of association to give directors a greater say in what happens to their business, enabling shares to be distributed exactly how they wish.
Shareholders' Agreement
Rules governing what happens to shares following the death of a shareholder may also be found in the shareholders’ agreement. Having such guidelines in place enables surviving shareholders to have a greater say in who can join them.
This can be extremely important, as shareholders may want to restrict certain people from joining their ranks and having a say on how their company is run. For example, they could wish to prevent a family member of the deceased who does not know the business from coming in and potentially making mistakes.
Shareholders’ agreements can also have several provisions included that protect the interests of the surviving shareholders and those of the deceased’s family. These include:
- Right of First Refusal: Stipulate that surviving shareholders must be given the chance to purchase the deceased’s shares before anyone else.
- Share valuation: Agreeing how the shares will be valued upon the death of a shareholder. For example, via the use of a predetermined formula or by instructing a forensic accountant.
- Timescales: Providing a deadline by which surviving shareholders must exercise their right to purchase the shares.
If there’s a conflict between the articles of association and the shareholders’ agreement, the former will take precedence.
Cross option agreements explained
Cross option agreements can also be used to give business owners more control over what happens to shares following the death of a shareholder. They do this by either:
- Forcing the personal representative to sell the deceased’s shares to the surviving shareholders or the company itself, or;
- Obligating the shareholders/company to buy the shares from the personal representative.
Under cross option agreements, shares can either be purchased by the surviving stockholders or by the company itself. Whichever method is chosen will ultimately depend on the unique circumstances of each business.
Purchase by surviving shareholders
This scenario enables the surviving shareholders to preserve the existing ownership of the business. Purchase by surviving shareholders also provides an efficient way for the beneficiaries of the deceased’s estate to realise the value of their shares without having to get involved in the company or deal with the transfer process.
Not only does this method leave the existing stockholders safe in the knowledge that no outside interference can threaten the security of the business, but it also ensures the beneficiary receives a fair valuation of the shares with a limited amount of fuss.
Purchase by the company
Alternatively, the company can purchase the deceased shareholder’s shares instead. There are extremely strict rules in place that govern how this solution is implemented, so it’s essential to speak to a specialist corporate solicitor to ensure everything is above board. If you get it wrong, it could involve the purchase being voided and a potential criminal offence being committed by the business and shareholders.
As with most large-scale purchases, it’s also important to consider the tax implications of enacting cross option agreements.
Consider insurance policies
Purchasing a deceased shareholder’s shares can be a costly exercise, either for the surviving shareholders or the business itself. To combat this, insurance policies can be taken out that trigger a payout when one of the shareholders dies. The type and number of policies acquired depend on whether the shares will be bought by the shareholders or the company.
In the first scenario, each stockholder will take out life insurance. The policy is then held in a trust for the remaining shareholders until the policyholder dies, at which point the funds are released and the money can be used to buy the shares from the deceased’s beneficiary.
If the company is going to buy back the shares, the business can take out a key person insurance instead, which will pay out when one of the shareholders dies. Again, the funds released by the policy can be used to purchase the shares from the beneficiary.
How old are the beneficiaries?
The ages of beneficiaries are also important to consider, especially when there are no provisions for the death of a shareholder in either the articles of association or shareholders’ agreements. If the beneficiaries of the deceased’s will are under the age of 18, either a trust will be formed to look after their interests or the assets will be given to the children’s guardians to control. This is dependent on the stipulations within the will itself.
Should a trust be formed, the trustees will be tasked with administering it. The trust will own the shares and benefit from dividends, while the job of voting on company issues falls to the trustees. If guardians are left the shares, they will become the shareholders and own both the shares themselves and the rights associated with them.
Why business succession planning is essential
What happens to shares following the death of a shareholder can be incredibly complex to unravel if the right provisions are not put in place. This can add an unnecessary level of complication and stress at what will already be a difficult time.
For business owners and surviving shareholders, the lack of suitable mechanisms can result in them being saddled with a new shareholder that knows nothing about the business, or even a protracted dispute that could threaten the future of the company. Beneficiaries, meanwhile, may be stuck with a firm they have no interest in or have no way of reliably valuing their newly inherited shares.
An effective business succession strategy takes away all the hassle and provides a clear roadmap for the company to continue growing. As a result, you can be confident that the firm you’ve worked so hard to build can carry on thriving, while also securing your family’s future.
Comprehensive business support tailored to your needs
Planning for the death of a shareholder requires a thorough and well-rounded approach to ensure everything is effectively managed. This includes drafting last wills and testaments, preparing articles of association, and setting up shareholders’ agreements. Additionally, the administration of the shareholder’s estate and addressing tax implications are important steps that must be taken.
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