Why shareholder protection could be a key part of your business succession strategy


If you own a business, planning for the future will be one of your top priorities.

You will, rightly, devote a lot of your time to putting together a strategy to grow it and work hard to ensure future success.

It’s also likely that you’ll spend time thinking about a succession plan. Clearly, you’ll hope that this can be planned in terms of your exit strategy from the business you have built. Maybe that will be based around when you want to retire, or at a time when you’re ready to step aside and move on to a different venture.

But you also need plan for unknown and unwelcome events, such as death and serious illness. In particular, you need to consider the effect these could have on your family, the business, and your personal finances.

One key area that I specialise in, and have helped Charlton House clients who own businesses with, is that of shareholder protection.

Case study: Artificial Intelligence 4U Ltd

Perhaps the best way to illustrate the importance of shareholder protection is through a very simple, and totally fictional case study.

Mr Smith and Mrs Jones are joint owners of a successful UK technology company, holding 50 percent of the shares each.

Mr Smith dies suddenly and although he has made a will, this simply states that his nominated beneficiary is his wife.

Mr Smith was the technology expert in the company, and Mrs Jones – as well as mourning the loss of her business partner – knows the business will suffer through the lack of his technological know-how.

Furthermore, the widowed Mrs Smith has no interest or expertise in the business she now finds herself owning half of. She is more concerned about her future wealth and wellbeing rather than running a company.

Just that very simple scenario shows you how problems can mount, both for the future of the business, and for the financial security of the surviving business partner.

Shareholder protection can protect you against unforeseen events

Because it’s easy for a sudden and unexpected event to upset even the most comprehensive business strategy, setting up a shareholder protection arrangement ought to form a key part of your plans. It’s like a will, but for your business.

In the event of a major shareholder dying or becoming critically ill, such an arrangement provides a lump sum to the remaining shareholder or shareholders that allow them to purchase the deceased shareholders shares from the beneficiaries of the will – whether that is the spouse, children, or any other beneficiary.

It means that any surviving shareholders have comfort of knowing that the deceased shareholders shares can be transferred to them, and that the future of the company remains in their control and not the control of the receiving family members or, even worse, a hostile shareholder.

It also means that the family of the deceased or critically-ill shareholder have the peace of mind that they’ll receive fair value for the shares rather than inherit illiquid shares in a company that might otherwise not be sold.

Finally, the arrangement provides contentment to all of the current shareholders, safe in the knowledge that should they die prematurely, then the shares of the business will be able to transfer seamlessly to their business partners and that their families will be adequately compensated for years of hard work, risk and sacrifice.

You can tailor shareholder protection to suit your business needs

Under a shareholder protection arrangement, it is important that various stipulations are in place that can control when and how the relevant shares will be purchased.

These can reflect the specific circumstances of your business and the wishes of the individuals concerned.

A typical agreement that is used is a “cross-option agreement” which gives the remaining shareholders the option to buy the deceased’s shares, either at the true market value, or a specified value which needs to be reviewed every three years, and gives the deceased’s personal representatives the option to sell the shares.

The means to buy the shares can be made available through a series of life insurance policies on the lives of the key shareholders concerned. These will be written in trust as part of the shareholder protection arrangements.

As well as providing protection to both your business and the families of the shareholders, a cross-option agreement is also a tax-efficient method of managing shares in the event of the death of a shareholder. This is because it will allow the deceased’s share to qualify for Business Relief, and, as a result, not be subject to Inheritance Tax (IHT).

Shareholder planning should cover more than just death or critical illness

While a cross-option agreement is primarily focused on the death of a shareholder, it’s also worth bearing in mind that you should draft  a shareholder agreement to address other issues and situations that may arise while all the shareholders are alive. We would always recommend using a solicitor who is experienced in this area.

These may include what will happen in the event that a shareholder wants to transfer their shares to another family member. It may give pre-emptive rights  – the right of first refusal going to existing shareholders in proportion to existing holdings before transfers to others –  or as part of the exit strategy you read about earlier in this article.

A lot of important planning matters are simply not covered in the standard model articles of association that are adopted by default when you set up a limited company

In reality, a shareholder agreement and a cross-option agreement are both key matters for consideration as part of your business strategy.

Key person insurance should also be a key business consideration

Another issue that I’m often asked about by clients who are business owners is that of key person insurance.

This relates to the potential impact on your business in the event of the loss of a key member of staff. For example, this could be someone who is not a shareholder, but has a specific skills, which would mean that their departure could create severe problems for the business.

A key person arrangement set up for this eventuality can provide your business with the means to cover the cost of hiring a replacement with a suitable skill set to ensure your business is not affected.

How Artificial Intelligence 4U Ltd used shareholder protection

So, let’s return to the case of Mr Smith and Mrs Jones, our successful business owners.

Fortunately, they had sought some financial planning services previously and set up a shareholder protection arrangement. They had valued the company at £5 million

Aside from drafting a shareholder agreement, they also individually took out a life insurance policy for £2.5 million each, being the value of their respective shareholdings. Each policy was written into trust for the other shareholder, which helped both of them from an Inheritance Tax (IHT) planning perspective.

To accompany this arrangement, they had signed a cross-option agreement, which gave either of them as surviving shareholders the option to buy the shares from the deceased shareholders beneficiaries for a specified price of £2.5 million. The cross-option agreement also gave the beneficiaries of the deceased shareholders beneficiaries the option to sell. If either party exercises their option it then becomes binding on all parties.

So, in this instance Mrs Jones decided that she would like to keep control of the company and she exercise her right to buy. She used the funds that had paid out from Mr Smith’s life insurance policy that was held in trust and transferred these to his widow.

The end result was that Mrs Smith was happy that she had realised the full value of the shares in a business her husband had worked in building for many years. Mrs Jones was equally happy as she was able to keep control  of the business without running into any voting issues or issues regarding building a business for a non-contributing shareholder.

Get in touch

If you need help with your business succession planning, we are here to help.

Please contact us by email or, if you prefer to speak to us, you can reach us in the UK on +44 (0) 208 0044900 or in Hong Kong on +852 39039004.

Please note

This blog is for general information only and does not constitute advice. The information is aimed at retail clients only.

The value of your investment can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance.

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