Of all the events that can negatively impact a business, the death of a shareholder is undoubtedly one of the most serious. Many businesses rely heavily on shareholders for their strategic and financial input and find themselves struggling without that person to turn to.
For those businesses that are not dependent on the contributions of shareholders to continue operating successfully, it is still important to consider the issues that could arise on the death of a shareholder, such as the impact on the beneficiaries of the deceased shareholder and the possibility that the remaining shareholders may no longer have full control of the business.
Shareholder protection can ensure that the beneficiaries of a deceased shareholder receive the true worth of the shares and allow the remaining shareholders to retain control of the business.
Although the surviving shareholders may have access to reserves or could borrow to acquire the shares from the beneficiaries of the deceased, an insurance policy, or series of policies, payable on the death of the shareholder, are often established to ensure capital is available to acquire the shares at agreed price.
In addition to having access to funds to acquire the shares, the correct legal framework should be in place to ensure that the purchase of shares can take place without disruption. This usually involves the drafting of a cross-option agreement, which sets out the options available to each party if a shareholder dies. It is also important to ensure that the company articles and, where applicable, shareholders agreements are appropriately worded. Otherwise, this can impact the tax treatment and viability of the arrangement.
Another major consideration in establishing shareholder protection is the valuation placed on the shares, which in turn will influence the level of insurance established on the lives of the shareholders participating in the arrangement. It is advisable that the company consult a professional, typically the company accountant, to determine the most appropriate valuation method to use.
An often-overlooked issue relating to the valuation placed on shares is the discount applied to minority interests. An insurance-backed shareholder protection arrangement could make it easier for the shareholders to disregard any discount for a minority interest and instead value each shareholder’s interest as a simple proportion of the total value.
It is also important to consider how any insurance plans are established as the plan owner, premium payer and beneficiary will influence the tax treatment applied to premiums and how the share purchase is administered. There are several options and not all will be suitable.
In summary, there are a number of financial and legal points to consider when setting up shareholder protection, and it is important that you seek coordinated advice from lawyers, accountants and independent financial advisers to ensure that all key aspects of the arrangement are suitable and appropriate. We have highlighted a few of the key points here but there are several others to consider.
At XV Wealth we are qualified to provide advice on shareholder protection arrangements. We can ensure that you put the right safety net in place to protect your business and loved ones in the event that the worst happens.
The above is for information only and does not constitute individual financial advice.
The content in this article was correct on 02/06/2024.