When it comes to owning and running a business, big or small, every business person sees their business as providing a continuous income into partial retirement or providing a lump sum on disposal to fund their retirement, in addition to any planning they do with pensions whilst alive. Our last article looked at the amount that can be paid into pensions and gave all general advice to ensure that you do not inadvertently breach the limits on annual funding.
This article looks at the scenario of you, the Shareholder, dying and leaving a non-participating spouse with shares in a business they have no intention of getting involved in, what do they do and how are they protected?
In that unfortunate event if you do not have a Shareholder or Partnership agreement, the shares or value of your interest in the business become part of the estate. In this scenario, there is no basis on which the business is valued and although the business will not be a taxable part of your estate for inheritance taxes (in most circumstances) once the dust clears, your spouse is looking for the value to be realised. In any scenarios, it is also likely that the surviving business partner will want to purchase the business from the spouse of their deceased partner once the estate clears probate. This clearly represents a potentially huge financial burden, as there may not be the available funds to do this. Also, the estate may not want to sell the shares. The two questions that will be being asked by each party are: –
- Spouse – “What is the business worth really and how do I realise that value?”,
- Business Partner – “What is the business worth from my perspective now by business partner has died and how do I buy out my business partners spouse and how do I fund it?”
Although I would love to say this would never happen, it does happen, far too often and it is not nice from anyone’s perspective. To ameliorate the risks, we always advise our clients to do one of two things:
Step 1. To protect the spouse and give fixed valuation methodology – They will have a Shareholder / Partnership agreement that sets out what happens on death;
Then they will!
Step 2. Take out an insurance policy on their business partner so that on their death, the surviving partner receives a lump sum to buy the business from their deceased spouse for an amount detailed in the shareholders agreement.
The first step will generally ensure the business has a suitable and up to date shareholder / partnership agreement, the most commonly used in the UK being a ‘cross-option’ agreement. This gives either party (the surviving business partner and spouse or recipient of the business assets) the legally binding option to buy / sell the shares. If either party exercises their option, in all cases the surviving shareholder must purchase the shares from the estate.
The second step is for either side to insure the risk and liability to ensure that if either business partner died that the risk of having to pay a large amount to buy the business interest is covered. In a business where you have two or more shareholders the monthly premiums are covered by the company but they become a benefit in kind. With multiple shareholders and individual policies, all underwritten with different premiums and loadings, it is acceptable to pool and equalise the premium so all shareholders have the same benefit in kind irrespective of age and health. If someone is uninsurable then this becomes a big issue that will be subject to a separate article.
To summarise, the shareholder / partnership agreement avoids disputes and gives control, and the life cover provides the necessary funds for the share purchase to happen. Not only does this assist with business continuity, but it also ensures that the estate receives a fair value quickly for their shares.
It is important that the correct structure is used for your specific business. In all cases, this is a very complex area that can cause significant problems if done incorrectly, so you should always seek financial and legal advice.
CEO & CIO
OCM Wealth Management