What happens to a business when someone dies?
6th July 2021
Samantha Wright, our Senior Partner, says the business upheaval caused by COVID-19 is a stark reminder of the need to have business continuity plans in place in the sad event an owner-manager dies.
What happens to a business when someone dies?
The consequences of the death of an owner-manager vary depending on the type of business concerned.
If the business is a sole trader, it ceases to trade on death but the assets can be sold as part of the estate.
A business trading as a partnership without a Partnership Deed that enables the surviving partners to continue will terminate on death. If there is a Partnership Deed (or LLP Agreement if it is a Limited Liability Partnership), the partners will be able to continue. What happens to the deceased’s interests (including their capital account) depends on the deed/agreement.
The outcome can vary if a business trades as a limited company. If the company comprises a sole director/sole shareholder, the deceased’s Personal Representative can use the shares to appoint a new director – assuming they can find someone to take the risk depending on the financial health of the company. The Personal Representative cannot vote with the shares for any other reason, which can cause problems to the continued operation of the company. Sometimes liquidating the company is the best option.
If we assume the company is solvent – and the director shareholder’s death does not alter that – it depends on what the company’s Articles of Association or Shareholders Agreement say. At BTTJ we recommend a Shareholders Agreement or Option Agreement (often supported by life insurance) that allows the continuing directors’ shareholders to buy the share back at an appropriate value from the deceased’s estate.
We often also suggest a Deed of Anti-embarrassment that allows the deceased’s estate to benefit if the company is sold in the not-too-distant future for more than the continuing shareholders paid the estate.
So what should my business do?
To put it bluntly, we highly recommend you talk to experts at a corporate and commercial solicitor like BTTJ because getting a legal solution in place will help mitigate upheaval in the event of an unexpected death.
Every situation, company, and set of shareholders has slightly different requirements or personal circumstances. However, they usually agree that the deceased wants to know their estate will get a fair pay-out and the survivors want the company to continue, but still be able to sell the company at an appropriate time – which can prove difficult if they don’t own or control the shares.
Resentment and opposing views often rear their heads after the unexpected death of a business owner.
For example, the deceased’s beneficiaries (particularly partners with children in the case of an early death) sometimes feel they should be receiving the same money/salary for the number of years the deceased had left to work – which isn’t usually viable.
Meanwhile, other senior figures resent working for the next 20 years for only 50% of the return on sale and refuse to declare dividends.
In short, it is messy and unpleasant.
What are the pitfalls if the appropriate measures are not taken?
The shares pass to the deceased’s beneficiaries. The continuing shareholders/directors don’t want to pay dividends forever and can’t sell the shares in the company when the time comes.
In most cases, it costs far more to untangle the situation afterwards than it does to put the right protection in place pre-death.
What type of business/business owner/director is most at risk?
All directors, shareholders, or partners are vulnerable. The overall impact depends on how much of the family’s (survivors and deceased) income comes from the business.
Can a director of a limited company leave his shares in a will? And does this mean the beneficiaries automatically become the new shareholders?
Yes and no. The deceased can leave instructions in a will, but often pre-emption rights in the Articles or Shareholders Agreement provide for them to be purchased before they form part of their estate. If it is structured properly, this process can reduce the overall value of the whole estate (and therefore Inheritance Tax – depending on whether Business Property Relief is available).
However, simply leaving the shares to your estate doesn’t enable the new shareholders to get value out.
Depending on the size of the shareholding, the new shareholders may not be able to appoint a director and consequently have no say in the running of the company or payment of dividends.
From an Inheritance Tax point of view, it isn’t always sensible to leave shares in a company to your spouse, because this potentially wastes the valuable Business Property Relief on those shares. We usually recommend that instead they are left to a type of trust called a Discretionary Trust, where the spouse is a potential beneficiary as well as children and other beneficiaries. The idea is that if the spouse doesn’t need the shares/ income then they can be passed down to the children tax-free provided the Business Property Relief is available.
The trust is flexible so if the relief isn’t available (for example, if the rules have changed or the business no longer qualifies for the relief) it can be re-arranged to pass the shares back to the spouse. In other words, we can look at setting the will up in the most tax-efficient way to make the best use of the reliefs available.
What are Cross Options?
A Cross Option can be put in place as part of a Shareholder Agreement. It gives each shareholder the legal right to sell his or her shares and the right to buy the shares of another shareholder in certain circumstances.
Articles of Association set out the rules for how the company carries on its internal business.
A Shareholders Agreement is recommended to regularise, define, and agree on the way the directors and shareholders will manage the company. It can include automatic rights to buy shares in several circumstances – if a shareholder dies, ceases to work in the company or becomes bankrupt – and can give minority shareholders rights to see accounts or be appointed as a director. A Shareholders Agreement can also include ‘Drag and Tag’ provisions ensuring that shares can be sold if the majority want to sell and that a minority shareholder isn’t left out of the sale.
All of these things can be in the Articles of Association, but a Shareholders Agreement doesn’t need to be lodged at Companies House because it is a private document.
Option Agreements are another method of granting the right to buy shares in the event of death or other circumstances, but they are most commonly combined with life insurance as the deceased’s shares can often be expensive to buy.
The company can only buy the shares back if it has sufficient distributable reserves, which may not be the case – especially if one of its main players has just died and the deceased’s estate cannot force this to occur.
So, by way of example:
Jane and Dave are equal shareholders, both work full time in the company, and are directors.
Jane insures her own life and names Dave as the beneficiary. Dave enters into a Declaration of Trust promising to use the insurance proceeds to buy Jane’s shares from her estate.
Dave insures his own life and names Jane as the beneficiary. Jane enters into a Declaration of Trust promising to use the insurance proceeds to buy Dave’s shares from his estate.
They both enter into Cross Options ensuring they have the power to buy the deceased’s shares and, if they don’t, the Personal Representatives have the power to make them do so.
The life insurance proceeds and the shares end up where they need to be, but the proceeds of the insurance do not form part of the deceased’s estate for inheritance tax purposes. The shares do form part of the deceased’s estate, but may have a lesser value (probate value and/or the benefit of Business Property Relief).
Should a company owner/director have a Legal Power of Attorney (LPA) in place?
Everyone should have both a health and wealth LPA registered and ready to go in case of an emergency, as well as a will. But an LPA will not help a director – an incapacitated director cannot delegate his director’s duties under an LPA.
Contact our highly experienced Commercial team for legal advice here