The importance of having proper succession planning and commercial agreements in place for partners, LLP members or shareholders cannot be over-emphasised.
•If anything happens to you, such as death or incapacity, what are your plans for the business?
•If misfortune befalls other shareholders or partners, what would you like to happen?
- The shares pass to their heirs
- The shares pass to you
- The shares pass to management and/or employees
- The business buys back shares
- The business is sold
- The shares pass to surviving shareholders or partners, with cash paid to heirs
Shares in unquoted companies are generally unmarketable and all the more so if anything happens to the company. On the death of a shareholder, there may not be anyone willing to buy a shareholder’s shares unless provided for by agreement.
Partnerships are even more vulnerable. On the death of a partner, in the absence of any agreements, the 1890 Partnership Act takes over by default. This means that the heirs of a deceased partner have an immediate call for cash for the value of the deceased partner’s share. This could spell serious financial trouble for the surviving partners. The other consequences would be as for a company if the partnership failed to survive.
Types of business agreements
There are generally two types of business agreements that protect the interests of shareholders or partners. The first is a ‘Buy and Sell’ agreement, the second a ‘Double Option’ (or ‘Cross Option’) agreement. Both types of agreement are used to dictate who will receive or purchase company shares or partnership share on the death, retirement or disability of a shareholder or partner. They need not be equal. For example, A has 80% of the company’s shares. B and C have 10% each. On the death of A, shareholders B & C will buy his shares equally. However, if B or C dies, shareholder A may not want more shares and B or C could purchase his shares.
It is usual for the partners or shareholders to insure each other, so that cash is made available immediately to buy shares.
Buy and Sell agreement
A Buy and Sell agreement is regarded as a contract for pre-sale and may lose valuable business property relief on death for inheritance tax (IHT) purposes, and incur IHT liabilities. Here, the agreement is a binding contract for sale, in the sense that the parties must act and exchange shares for cash. This type of agreement is mandatory on the happening of a certain event, such as death, and is not flexible.
Double option agreement
This type of agreement is one of sale after death and may happen – if the option from either side is activated. Consequently, any available business property relief in respect of the shares should be preserved for IHT purposes. For example, A, B, and C are equal shareholders and A dies. In terms of the agreement, the representatives of A’s estate have the option to call on B and C to buy his shares from the deceased estate. Likewise B and C have the option to call on the deceased’s estate to sell the shares. As soon as one party triggers the option, the other must act. If both parties decide not to act, then the deceased’s estate keeps the shares (and B and C keep the life assurance arranged to buy the shares).
This type of agreement is one of sale after death and may happen – if the option from either side is activated. Consequently, this type of arrangement can be IHT efficient.
Practical Tips :
•If you do not have agreements in place, then get one.
•If you have a Buy and Sell agreement in place, then perhaps a double option agreement will be more effective or tax efficient for you.
•Insure the partners or shareholders as part of the agreement – this makes cash available to buy the shares. Policies can be held in a business trust.
•The agreement can also cover critical illness or disability if a partner or working shareholder leaves the business – his or her shares can pass to others.
•Check the levels of cover on a regular basis - as the value of the business changes, so should the policies providing cover.
•Check if current agreements are out of date. Update them if necessary.
•Save business property relief for IHT purposes if applicable, through having
double option agreement.
Properly structured business agreements are akin to having a will for the business and forms part of your succession planning. It will protect the business and business owners whilst creating instant marketability of shares, and cost-saving premium strategies can make your protection planning an inexpensive exercise.