The loss of a co-shareholder in a company or business partner is often overlooked as a risk. When a business owner dies, becomes disabled, or suffers major health trauma, the impact on the company can be significant, disrupting operations and causing financial strain. To manage these risks, a robust buy/sell agreement – sometimes called “Compulsory Share Sale Agreement” – and buy & sell insurance cover can help. They can protect against these risks. They ensure the surviving partner can buy out a deceased or disabled partner’s interest.

However, it’s crucial to seek expert financial advice from a life insurance adviser as part of the planning process. They can design a funding strategy using life insurance. It will ensure capital is available to buy out the affected shareholder’s interest, without burdening the business with debt. This approach safeguards the company’s stability and provides peace of mind for all involved.

Upon a Business Owner’s Death or Disability, the Remaining Owners Have One of Five Options:

Co-Shareholders Consideration

The first step to take is understanding the structure of your business. Are you a sole trader, or is your business run through a company? If it is a company, who are the directors and shareholders?

When a company has multiple shareholders, it’s crucial to review the shareholders’ agreement. It may limit your rights with your shares. If you die, other shareholders may have the right to buy your shares. Shareholders’ pre-emptive rights let them buy more shares before the company sells them to another party. Generally, surviving shareholders will have no interest in having the deceased/disabled shareholder’s family involved in the business. Equally, the deceased’s family may have no interest in being involved with the company and would dictate that the shares are sold.

Here are a few key considerations:

1. Share Transfer Restrictions: The agreement may limit how shares can be transferred. It may include rights of first refusal or buyback provisions.
2. Buy-Sell Agreements: They often outline what happens to a shareholder’s shares upon their death. This includes whether other shareholders can buy them.
3. Family Considerations: Dealing with a deceased shareholder’s family can be complex. They might not want to be involved in the business. Managing these dynamics requires sensitivity and clear agreements in advance.
4. Business Continuity: Clear plans for such situations help avoid business disruptions.

If you and your co-shareholders agreed to buy out a deceased member’s shares, check for life or key person insurance on the other shareholders. This insurance ensures funds are available to buy the deceased’s estate, as per the shareholders agreement.

Buy/Sell Insurance Cover – Is the Most Effective Solution

We believe, no debt should outlive the person who created it. A buy/sell agreement paired with Shareholder Protection Insurance, or Buy & Sell cover, ensures the family gets fair value for the deceased or disabled person’s interest. Insurance funds are used to buy the deceased or disabled person’s shares in the company or partnership. It could be used to clear debts. The company maintains stability and achieves peace of mind in the unfortunate event of death or serious injury.

Usually, the company pays the insurance premiums. They debit the cost to the relevant shareholder’s current account. This is the shareholder or partner who owns the policy.

What Does a Buy/Sell Agreement Typically Provide

1. Ownership of insurance policies: Shareholders will usually have an independent third party hold them on trust for the shareholders. An independent person can handle the insurance proceeds. This can reduce stress and ensure a smooth process.
2. Payment of insurance premiums: The shareholders may pay the insurance premiums. Or, they could require the company to pay them.
3. When a share sale is required: What events will trigger a share sale under the agreement. An insurance policy may pay out for events like:
   1. a shareholder’s death,
   2. a shareholder’s total and permanent disablement, or
   3. a critical injury or illness to a shareholder that prevents their return to the business.
4. The share sale process: The agreement will outline how to sell the shares to remaining shareholders. The instructions will specify when to settle, and what documents and conditions are needed to complete the sale.
5. The sale price for the shares: The agreement will also state the price for the shares. A fair valuation, formula, or the value of the insurance proceeds could serve as the basis for payment. Your accountant can provide advice on this point before deciding.

Calculating the Cost of Borrowing to Buy a Deceased/Disabled Partner

When a business partner dies or becomes permanently disabled, one of the key considerations is determining the cost of borrowing to finance the buyout.

This involves:

1. Assessing the value of the deceased or disabled partner’s shares.
2. Understanding the terms of any available financing options.
3. Evaluating how the borrowed funds will impact the business’s financial health.

It is vital to calculate these costs correctly. This ensures the buyout can be managed without straining the company or its remaining owners.

Here’s a detailed analysis of borrowing $800,000 with a 7.50% interest rate over a 10-year period:

Next we must calculate the amount of income and gross company sales required to repay the loan:

Comparing the $9,437 monthly loan cost to the life insurance premium makes the decision clear:

Neglecting Succession Planning – Could Your Business Cope Without You?

Business owners often neglect succession and asset planning. They’re too busy running their business. Unfortunately, a lack of planning for your death can burden your partners and loved ones. They will have to pick up the pieces. You should pause and consider this: what if you’re gone tomorrow? What would happen to your business? Can you imagine being in business with your deceased partner’s family? They have their own lives and careers to focus on. Not to mention grieving for their loved one.

Conclusion

If a shareholder or owner dies or is disabled, the best solution is a shareholder buy/sell agreement and Shareholder Protection Insurance. This cover lets shareholders continue operations if one dies or becomes incapacitated. It’s a key part of future planning. A written agreement can let the remaining partners and shareholders buy the shares. This keeps things running as intended. It also ensures the deceased partner’s family gets a fair price if the remaining shareholders buy the shares, without overburdening the business.

An efficient, effective business protects jobs and investors’ livelihoods. Our example shows that a $300 monthly insurance premium is a small investment. It is much less than the $9,437 monthly loan payment needed to fund a buyout. Planning for the unexpected in advance ensures business continuity. It also provides peace of mind. It’s wise to review your business continuity plans and shareholder agreements each year, or following after any major changes.