As we reflect on 2020, we will no doubt remember how unexpected life can be and how much is out of our control. However, there is one aspect of our lives we can control, and that is our estate planning. As we start 2021 with anticipation and possibly some trepidation, there is no better time than now to take control of your succession plan.
The succession plan for a family business can often be quite complicated, especially where only one or some of the founder’s children work in the business or are interested in the business. Leaving your business interests to only those children who work in the business can cause disenchantment among the children resulting in a potential challenge to the Will. Careful planning is required but there are strategies which can be implemented to mitigate any potential risk of dispute between those you leave behind.
In this article we will review the importance of shareholder agreements and buy/sell agreements, and what can happen when these documents are not in place prior to death or incapacity.
The value of formalising business owners’ arrangements
Shareholders’ and unitholders’ agreements are increasingly being implemented for companies or trusts that involve two or more arms’ length parties. There are very good reasons for this trend: such agreements help to guide decision making, establish governance procedures and stipulate mechanisms to resolve deadlocks.
Business owners are also increasingly entering into what is commonly called a ‘buy/sell deed’. This is a deed under which the owners of a business entity agree that, if one of the owners dies or becomes permanently disabled, the others will have an option to purchase that owner’s equity.
Again, there is a very good reason for this trend. Specifically, owners are wary of having to be “in business” with whoever may become entitled to the control of the shares of the deceased or disabled owners (often the spouse or the children of the relevant owner).
Importance of owners’ arrangements in succession planning
Unfortunately, these crucial agreements are often overlooked in the context of succession and family-owned businesses.
For example, a business may have been started by a parent through a company in which he or she holds all the shares. Over the years, all three of their children have become involved in the business. The parent intends for the business to stay in the family and wishes to leave the business to those three children in equal proportions. Accordingly, the parent’s Will makes provision for each of the children to receive one-third of the shares upon the parent’s death.
As the parent was the only shareholder until their death, the company has no shareholders’ agreement or buy/sell deed. The company constitution includes the usual provisions allowing a majority of shareholders to appoint directors by ordinary resolution, to control the issue of shares and generally to control the affairs of the company.
If for any reason, one of the children falls out with the other two after the death of the parent, the two “majority” children can now effectively exclude the third one from the affairs of the company. They could remove any representation that person had on the board of the company. They may even seek to dilute the holdings of the third shareholder.
The minority child’s only remedy may be to ask a Court to step in to prevent or rectify any oppression. While a Court will often grant some relief in these circumstances, the nature and extent of the relief to be granted is hard to predict. The litigation process will also usually involve significant costs.
Alternatively, if one of the children subsequently passes away, their shares will be dealt with in accordance with their Will. For example, this may result in their shares being held by a spouse who was not intended by the parent to be a shareholder in the company.
Implementing owners’ arrangements in succession planning
There are various potential ways to overcome these issues.
If the business is conducted through a company or a unit trust, it is possible to make the gift of the shares or units under the Will conditional upon the entry into a shareholders’ (or unitholders’) agreement and a buy/sell deed. This would mean that each of the children in the above scenario would be required to execute the agreement and deed before they become entitled to the shares.
The shareholders’ agreement could:
- Ensure that each of the children had the right to appoint one director to the board (presumably themselves) even without a majority of votes
- Make certain key business and corporate decisions (such as the issue of further shares) dependent on a unanimous agreement.
The buy/sell deed could ensure that the shares stay in the family by, for example, giving each of the children an option to purchase the shares at market value if one of them dies or becomes incapacitated.
Alternatively, some of these mechanisms could be implemented by a change to the company’s constitution (and/or the deed of the relevant trust).
We can help
Rigby Cooke’s Wills, Trusts & Estates and Tax teams include experts in succession planning, taxation and business governance issues. Together, we can provide business succession strategies that are effective from both commercial and tax perspectives.
We will help to implement your wishes and protect the business you have worked hard to build.
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