The death of a business owner isn’t the most uplifting topic, but it is vitally important if you own a family business (or a share of one.) Family businesses tend to blur the lines between professional and personal interests, which can also leave them exposed when an owner passes away. Thinking about your wishes now as part of the exit planning process could prevent family feuds and costly legal bills in the future. A business dispute is the last thing you want to leave your family when they are grieving your loss.
In this blog, we’ll look at the types of legal documentation and policies every business owner should put in place to protect themselves and their family.
The need for succession planning in a family business
Grief brings strong emotions to the surface and changes people’s perspectives. The goals and ambitions we once had to join the family business, can quickly change following the loss of a family member. Issues can become complex and emotional, especially when a family is split between people who work in the business and those that do not, or when there are business partners who aren’t family members.
Succession planning has practical and legal implications and gives clarity on what happens next when the owner of a family business dies. If you don’t plan, you could unintentionally leave costly challenges for those left behind.
1. Make a Will and update it regularly
It’s astonishing how many people don’t have a Will. If you don’t have one, you can count yourself alongside Martin Luther King, Pablo Picasso and Bob Marley, who all died without leaving a Will and left huge legal battles for their families.
A Will allows you to set out how you want your assets to be distributed after your death. In 2008, the actor Heath Ledger died without refreshing his Will to include his young daughter, meaning she stood to inherit none of his $20million estate. Fortunately, his parents and siblings agreed to put the money into a trust for his daughter.
Not every family is as generous as Heath’s.
Unless you have documented your wishes for your family business separately, your personal Will should also address what you want to happen to your business after your death. Solicitors advise to review and update your Will at least every 5 years, or sooner if you go through significant life changes such as a divorce or add to your family.
When writing your Will, make sure you pass your business to someone who actually wants it. Imagine your surprise (or perhaps horror) at discovering you’ve been left a share in a business you weren’t expecting! Forewarned is forearmed.
Think about the following questions when making your Will:
- What do you want to happen to your business when you die?
- Who would you like to make day-to-day decisions when you’re not around?
- Who will take ownership of your business or your share of the business?
- Do you want the business to continue running as normal or to be sold? If it is to be sold, how do you want your share of profits to be allocated?
If you were to die without a Will (known as intestate), the rights to any shares you have in a business pass to the state, meaning your next of kin has no say in decision making or rights to dividends until probate is granted. It makes sense to make a Will!
2. Shareholder Protection
Shareholder protection is an insurance policy that will pay out on the request of the beneficiaries of the deceased or the surviving shareholders. The policy will cover the value of the deceased’s shares to enable the remaining shareholders to purchase them. It means any remaining shareholders won’t have to scrabble to find the funds or take out a loan to buy the deceased’s shares and the shares remain within the business. Equally helpful whether it’s a complete family business or the deceased was the only relative within the business.
3. Keyman insurance
Keyman is another type of insurance policy that offers protection for a key person in the company, for example a top sales person who brings in the majority of new business. It’s a useful insurance to have if one shareholder is the primary earner and active driver of the business and other shareholders are more passive like sleeping partners.
4. CrossOption Agreements
These agreements dictate the order in which things have to happen, e.g. if the deceased owner’s family want to sell their inherited shares to the surviving shareholders. CrossOption Agreements are legally binding (often linked to a Shareholder Protection policy) and therefore cannot be declined.
5. Shareholder agreements
A Shareholders Agreement sets out the ground rules for how your business is managed. They may also be used to set out possible areas of dispute and outline how these are to be resolved. These are usually created at startup stage when you form a limited company. Where a company converts from a sole trader or partnership, the importance of a Shareholder Agreement can be overlooked, causing problems further down the line. If you think your business might be affected, speak to your accountant as a starting point to rectify the issue.
6. Articles of Association
Articles of Association set out the rules for running a limited company and must be agreed and followed by all shareholders and directors. If you set up your business from 2006 onwards using the Model Articles of Association, you benefit from a standard clause allowing the deceased’s representatives to appoint a replacement director. For companies set up before 2006, it is unlikely you will have this clause in your Articles, meaning in the event of the business owner’s death, their family may have to go to court to acquire shareholder rights.
It’s therefore crucial that you check the wording of your Articles of Association now to avoid legal costs and time delays in the future.
Be aligned and consistent
Treat your business protection policies as a suite of documents that dovetail seamlessly together. If you change one document, review them all to make sure they are aligned and don’t contradict each other. Discrepancies or loop holes could be picked up and exploited by a legal professional when you’re no longer around. Make sure your wishes are clear and cannot be misinterpreted.
There are no guarantees in life or in business. Planning your business exit isn’t just thinking about selling up and retirement. When a business shareholder dies, their shares will become part of their personal estate unless they have put in place other legally binding documents to dictate otherwise. If you would like professional guidance around making an exit plan, book a free discovery call with one of our team.
Alternatively, if you do one thing after reading this blog please make or update your Will to include your business.
