Death of a Shareholder

Death is never an easy topic, particularly when it comes unexpectedly. Initially, the focus is on the emotional impact and coming to terms with the loss. Inevitably though, attention must turn to practical matters including dealing with the affairs of the deceased. 

The starting point of estate planning usually involves a Will and letter of wishes, but estates containing business interests require more careful thought. Failing to plan effectively can ultimately result in a particularly challenging and costly exercise. Additionally, the business itself may suffer badly if there is a lack of clarity surrounding its management and ownership. 

The problem  

There are major risks for business co-owners which include ending up in business with someone that you either don’t know or don’t like, and unexpected tax liabilities that may need to be funded out of the business, impacting upon business viability.

What happens to shares held by an individual upon their death depends on whether they made a valid Will. If a Will is found, legal title to the shares vests in the shareholder’s executors automatically on death. A well-considered Will should contain administrative provisions allowing the executors to run the business if needed, even before a grant of probate is obtained. If the shareholder dies without a valid Will, the family members who intend to act as administrators will need to obtain a grant of administration before they can take steps to engage in formal business decision-making.

Even though shares may automatically vest in executors on death it is common for a company’s articles to require them to prove their entitlement to the shares, which means they will likely still need to obtain a grant of probate first. Once a grant (either of probate or administration) has been issued, the personal representatives will usually have a choice of requesting that the shares be transferred to them, or alternatively transferred to a beneficiary named in the Will or sold without ever being registered as members themselves.

Unless there are provisions to the contrary, the person who ends up with the shares (the beneficiary) can transfer them freely to anyone they choose. However, in practice it might be difficult to find a buyer as the market for those shares is likely to be limited. On the other hand, it can be very difficult to force an awkward shareholder to exit the company and to sell their shares unless the articles have suitable provisions.

For a family business, an unexpected change in the ownership of the company could lead to significant uncertainty and worry for other shareholders as well as non-owning directors, or result in costly disputes.

Planning to avoid this problem

While existing shareholders will want to carefully consider their estate planning, including taking time to ensure the content of their Wills matches their personal goals, the board of directors should also be proactive in preparing to avoid the worst risks.

The starting point is to identify what is the desired outcome for the company when a shareholder dies; who should ideally end up with the shares and what rights should attach to them going forward?

Here are some potential solutions:

• The company could be given the right to buy back the deceased’s shares from the estate, leaving the value with the deceased’s family but control remaining undiluted;
• Surviving shareholders could be given an option to purchase the shares from the estate and/or  the estate can require the surviving shareholders to buy the shares from the estate; or
• Beneficiaries of the estate could be allowed to retain the shares but with limited rights attaching to them to keep decision-making with the surviving shareholders.

Implementing a solution 

For the company, the starting point is its articles of association.

It’s common to see compulsory transfer provisions, where the deceased shareholder is deemed to have submitted a transfer notice to the company, and the estate is then subsequently required to transfer those shares as directed. However, such provisions are likely to jeopardise the availability of business property relief to reduce inheritance tax liabilities in the estate of the deceased. For this reason, cross option agreements on death are likely to be more suitable, even if compulsory share transfer provisions are retained in articles for scenarios other than death.

Notably, option agreements do not necessarily require the company itself to be a party. A cross-option agreement will typically prescribe that on the death of a shareholder:

• The surviving shareholders can require the estate to sell the deceased’s shares to them (in proportion to their existing shareholdings); and
• The estate can require the surviving shareholders to buy the deceased’s shares from them (again, in proportion to their existing shareholdings).

When drafting such agreements, a lawyer will go back to the fundamental question: when a shareholder dies, who should ultimately own the shares? This may be a different person than the individual the shareholder intends to pass the capital value of their shares to. Careful drafting is still needed to ensure that there is no deemed ‘binding contract’ at the day of death which could threaten the availability of business property relief. 

In some cases, particularly in larger family businesses, there can be a desire for family members or other beneficiaries to retain the shares and enjoy the associated economic benefits. The key point is to ensure that the continuity of the business is not jeopardised – use of different share classes with varying voting rights can be helpful in this regard. 

Funding issues

Funding issues can pose significant challenges, especially when the business is thriving, and the deceased’s shares hold substantial value. If the estate is selling the shares, the personal representatives are obligated to secure the best price for the beneficiaries, which can complicate negotiations with those already involved in the company.

A buyback arrangement is often appealing because the company itself funds the acquisition rather than the shareholders (as buyers). However, directors must be cautious. The buyback must be financed from the company’s distributable profits; otherwise, it will be invalid. Moreover, it must be structured with immediate payment upon completion; deferred consideration is not allowed.

Cross-option agreements are often funded by life assurance policies that provide the necessary funds upon a shareholder's death, enabling the surviving shareholders to purchase the deceased’s shares. Life assurance can obviously only be purchased during lifetime, and the policies will need to be structured to ensure the benefit of the policies passes to the surviving shareholders rather than the deceased’s family.

Inheritance Tax

Under current legislation, interests in a qualifying trading business may benefit from full relief from inheritance tax. Changes announced in the October 2024 Budget will cap the availability of business property relief to a maximum of £1 million. Shareholders with business interests with greater value than £1 million (even across multiple businesses) will no longer qualify for 100% relief from inheritance tax.

If a shareholder’s estate has insufficient assets outside of the business to fund tax due, personal representatives may ask the company to fund the tax due upon the shareholder’s interest in it. This could impact business viability if there is insufficient cash or insurance to fund the tax.

Taking advice

Future-proofing a business and its ownership is not always a simple or cheap exercise. The aim is to provide clarity, which requires precise documentation. 

However, the risks of neglecting this issue can become far more severe. In the worst-case scenario, the consequences may include: significantly higher costs due to tax and legal and other advisory fees; considerably more time to reach a resolution; irreparable damage to family relationships; and substantial stress and anxiety along the way.