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Protecting your Business Against Shareholder Death

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This article has been submitted by Greenaway Scott

Benjamin Franklin was right when he said that nothing is certain except death and taxes. Neither concept is one we give much thought to but consequences can follow if plans aren’t put in place before a shareholder passes away.

The Problem

A shareholder’s business interest forms part of their estate and passes to their beneficiaries on their death. This can mean that the running of their business is also left to them.

The issues here are:

  • Beneficiaries won’t know how to run the business and may not want to try however they will be entitled to part of the profits and capital.
  • Surviving shareholders may have to consult or seek approval from beneficiaries regarding business decisions.
  • Beneficiaries may require that business profits are distributed as dividends which may not benefit the business.
  • Surviving shareholders could want to buy out the beneficiaries but not have the resources.
  • Valuations of the business interest can differ making it difficult for beneficiaries to sell the business interest if there isn’t a market for it, lumbering the beneficiaries with shares in a business they can’t sell and don’t want.

The Solution: Cross-Option Agreements

A cross-option agreement is the grant of put and call options and its fundamentals are simple: each shareholder agrees that upon his death his fellow shareholders have the option, but not the obligation, of buying his shares (the ‘call option’) and his personal representatives have the option, but not the obligation, of selling his shares to the surviving shareholders (the ‘put option’).

The methodology for valuing the business interest will be outlined in the cross-option agreement and is usually based on market value.

Simultaneously, each shareholder takes out a life policy written in trust for the surviving shareholders to fund the deceased’s business interest under the cross-option agreement. Structuring matters like this means that it‘s possible to ensure that the shareholder’s business interest qualifies for up to 100% business property relief from inheritance tax.

A properly-drafted cross-option agreement coupled with associated life policies ensures that a business can continue without the uncertainties a shareholder’s death can bring. It will also provide a tax efficient mechanism that the beneficiaries can extract value from a business.

If you would like to discuss cross-option arrangements and safeguarding your business, please contact Leanne Thomas or any member of the Corporate Team at Greenaway Scott.