Families inheriting large business stakes can make terrible mistakes - Spear's Magazine

Families inheriting large business stakes can make terrible mistakes

Owner-managers and shareholders in private companies spend their lives working hard to build a business, usually intending to pass the benefits of that business to their spouse or children when they die. However, they don’t necessarily expect – or even want – their spouse or children to have control of the day-to-day running of the business.

Most owner-managers and shareholders expect that after death their business partner or co-shareholder will continue to run the business and perhaps even purchase their shares in the business, with their family receiving the proceeds of sale from those shares. The first mate will take the wheel and the ship will stay on course with minimal disruption – but this can only happen if the necessary contingency plans have been put in place.

In practice, preserving company shares on death isn’t always so straightforward. In many cases, the death of a shareholder means that family members, who know perhaps very little about the ins and outs of the business, hold the shares as part of the deceased shareholder’s estate.

The family, in effect, can therefore have a say in the day-to-day running of the business, which has the potential to be disastrous – imagine the passengers of a ship suddenly being forced to sail it.

A further problem can arise where the remaining shareholders wish to buy the shares and the family agrees to this, but the remaining shareholders don’t have the financial resources available to fund the purchase.

Taking the helm and charting the right course now can prevent this. It is important that the shareholders have in place a structure which ensures that on the death of any shareholder there is the protection and flexibility not only for the remaining shareholders in the business, but also for the family members of the deceased. This structure can be achieved through the use of a cross-option agreement.

A cross-option agreement gives an option for the remaining shareholders to purchase the shares (a ‘put’ or ‘call’ option) on the death of a shareholder. After death, the remaining shareholders can exercise their option (the ‘call’ option) under the agreement to buy the deceased’s shares. Alternatively, what may happen is that the deceased’s personal representatives exercise their option to sell the shares (the ‘put’ option).

This helps navigate through the first hurdle of the deceased’s shares being held by the family members, however, the additional – often fundamental concern – is money. How can the remaining shareholders actually purchase the shares if they have insufficient funds to do so?

This second hurdle can be overcome through the use of cross-option insurance, which for tax planning purposes is often written into trust. The insurance will pay out the sum insured, which should be sufficient to buy the shares. The result of this arrangement is that the remaining shareholders own the shares and the family members receive the proceeds of sale.

Cross-option agreements must be drafted carefully so as not to hinder the deceased’s estate from claiming business property relief. This is a valuable relief that can provide a 100 per cent deduction of the value of a qualifying interest in a business for inheritance tax purposes.

To add further food for thought, the shareholders should also ensure that they have tax-efficient wills in place, allowing for overall flexibility and protection of their assets.

With some careful planning, owner-managers and shareholders can ensure that their ships reach safe harbour – even when they are no longer at the helm.

Rebecca B Wardle is a private wealth solicitor at Trowers & Hamlins