It was Benjamin Franklin who once said “…nothing can be said to be certain, except death and taxes.”
Business owners know only too well the importance of dealing with taxes, but rarely think about or plan for how they will deal with the death of a business partner or shareholder.
As a nation, we’re not good at talking about death. So, it is hardly surprising that recent research shows that half of UK adults don’t even have a will. Yet, as Here Jen Goodwin, a solicitor in the corporate and commercial team at solicitors Jackson Lees explains as a business owner, failing to plan for death is a serious risk, not just to your family but also to your business.
As unpleasant as it is to think about, a responsible business owner needs to have considered what will happen to ownership of their business if they or a co-owner dies or becomes seriously ill while still active in the business. Indeed, it is healthy to include these issues as part of your business continuity and risk planning particularly when you consider a Legal & General survey which found that 59% of businesses believed that they would have to stop trading in less than a year after the death or critical illness of a key individual.
Aside from not wanting to think about the worst, one of the reasons more businesses don’t plan better around death or critical illness is because they wrongly assume that their families will automatically benefit from the value built up in the business in the event of their death, but that is not necessarily the case.
The default position is usually that shares in a company will pass to the estate of the deceased, leaving family members with shares and not cash, and surviving co-owners with new shareholders who often have little or no working knowledge of or interest in the company. It can be a less than ideal situation for both sides.
Yet, there is a simple solution to avoid this by having a cross-option agreement.
What are they?
A cross-option agreement is a contract between the shareholders of a private limited company and is a private document that does not need to be filed at Companies House. It gives the other shareholders the option to purchase the shares of a shareholder who is incapacitated or has passed away. This option allows the surviving shareholders to retain control of the business without having to introduce new shareholders.
The agreement will also provide the beneficiaries of a deceased shareholder (very often the spouse, children or other close family members) a similar option to require the surviving shareholders to purchase the deceased’s shares, just in case those surviving shareholders don’t exercise their own option to buy.
For those left behind, whether personally or professionally, it provides real peace of mind. For family members, it provides certainty that the demands of the business will not fall on them and for those left in the business, it provides clarity as to the business’s future.
Importantly, as the name suggests, cross-option agreements provide just that, options. The parties do not have to exercise their rights under the options. If neither the surviving shareholders nor the estate of the deceased exercise their rights then the shares will be inherited in accordance with the relevant will or intestacy rules and any applicable shareholders agreement, which might be particularly welcome in a family-run enterprise where one individual has been identified to take over from the deceased.
What is included?
The main elements of a cross-option agreement include the details of the shares eligible to be bought or sold, the rules around how the shares are to be valued (or if there is to be a fixed price) and a timescale as to when the transaction should take place and payments be made.
Valuing and paying for shares on death
Depending on the terms of the cross-option agreement, the shares may need to be independently valued. Some agreements contain a formula which might take into account market value and a multiple of profits. There will of course be tax implications for both sides in any sale and it is absolutely essential that both sides seek independent financial advice prior to entering into a cross-option and on exercising their option.
The cross-options are very often backed by an insurance policy taken out by each shareholder known as a shareholder protection policy. This is so that when an option is exercised, the purchasers have the cash available to buy the shares, otherwise they may need to fund the purchase price themselves or find a way for the business to fund it, which many will be unable to afford. This can leave a surviving shareholder in the very difficult position of being legally bound to purchase shares following exercise of an option by the estate, but without the money to be able to pay the purchase price.
These insurance policies are different to ‘key man’ or ‘key person’ insurance, which simply insure the business itself against the losses stemming directly from the absence of a critical person. Shareholder protection insurance pays out to the owners of the business for the sole purpose of acquiring the shares of the deceased or critically ill shareholder.
What else to think about?
At the same time as completing a cross-option agreement, you should also update your will to reflect what is in the agreement.
Just as important is to review and renew the cross-option agreement and any shareholder protection insurance every few years to make sure it still reflects the current business and value.
While you may not consider making such provisions for your business when you’re still young, fit and healthy a priority, considering a cross-option agreement could be a fundamental part of securing your businesses legacy.