Why death provisions in Shareholders’ agreements are important

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It’s never easy dealing with the aftermath of events (Including emotional) and business-related admin when a shareholder in your company dies.

When a shareholder dies, it is usual for his or her shares to pass to whomever inherits the shares through his or her will (or through the intestacy rules if there is no will) unless there is a specific provision in a Shareholders’ Agreement.

Some of the most important issues that could arise if shares do pass through a will or intestacy could include:

You lose control of the company’s ownership and direction

The shares could pass to anyone – even someone you don’t know. These third parties may not share the same goals for your business and may not understand your company’s vision. This could be highly problematic for you when you try and drive the business forward and make business decisions. If the shareholding was significant and came with voting rights, the third parties could effectively be in control of your business.

There is good news, even for the darkest of topics. You can be very specific in your Shareholders’ Agreement as to who your shares should pass to in the event of your death. You can go further to include provisions that indicate that any inherited shares do not come with any voting rights or rights to become a director of the company, for example.

A lawyer can advise the company on general death provisions, but it is recommended you seek independent legal advice individually, as the Shareholders in your company, to ensure your own interests are completely protected.

You may not be able to afford to buy out the deceased’s shares

You may have agreed to include a provision in the Shareholders’ Agreement that requires your shares to be transferred to existing Shareholders on your death or alternatively, transferred to existing Shareholders if anyone who inherited your shares decides to sell their shares, for example.

If the Shareholders don’t have any upfront capital to purchase these shares, it can be quite problematic. If existing Shareholders can’t afford to buy the shares, they could be offered out to a third party (even a competitor!), which brings us back to the first point, above.

There are a few things you can do to prevent this from happening, though.

  • Get a shareholder protection policy

This is a type of life insurance policy taken out on the Shareholders. Here, the remaining Shareholders are the beneficiaries in the policy, so if a shareholder does die the remaining Shareholders can buy out the deceased’s shares.

  • Get an agreement in place to ensure the smooth transition of shares.

This is usually a cross option agreement that all Shareholders will enter into. All Shareholders take out a protection policy on either themselves or each other and they agree to fully cooperate with any claim upon the death of a shareholder. This is all put in writing in an agreement.

  • Agree in advance how shares will be valued in the event of a Shareholders’ death.

It’s common for privately held companies to incorporate provisions for how shares will be valued if a shareholder dies and they have the right to purchase those shares. Often, Shareholders’ Agreements will include formulas or will agree on calculating a fair market value given by an independent valuer at the time of a Shareholders’ death.

Plan ahead

We know this is a topic nobody wants to discuss. Starting a business is supposed to be fun, but being in business also means you need to take any action necessary to protect you and your business in advance. Planning ahead is key.

If you’re thinking about getting a Shareholders’ Agreement or would like to have your current agreement reviewed, we’re always on hand.

Tend Legal Limited, London