BGBG

EveryMonth (Jan 2011): Planning for Succession in Business

Common structures

The most common arrangements are;

  • Life policies that pay proceeds to surviving business owner(s) on death (and perhaps on critical illness).
  • Cross option agreements that give the surviving business owner(s) the right to buy the shares from the deceased’s family using the policy proceeds – a ‘Call Option’. The deceased’s family will have separate right to compel the purchase by the survivor – a ‘Put Option’.

When these arrangements work best

For 50/50 owned companies these structures can work very well and can provide real peace of mind.

Your key driver may well be that you and your surviving business partner should have a ready and simple mechanism to take 100% ownership and control of the company. You should not, when faced with the challenge of running the company without your partner have the additional challenge of co-ownership of the business with your business partner’s family.

Often an owner will agree that the survivor should not have to deal with valuers and uncertain and costly valuations, so these arrangements will generally link the purchase price of the shares to the life policy proceeds and have no valuation mechanism which could leave the deceased’s family with a residual shareholding. After all, the arrangements are not actually conceived to provide life cover for the family but a mechanism to buy out the shares on death!

The arrangements will instead envisage annual reviews of the level of cover under the life policy so that these are in line with the company value.

What if your company is owned substantially by one person not by two or more owner-managers?

These situations will be more complex commercially and hence legally. The first question must be: is there a management team in place that could take over the running of the company?

If the answer is ‘no’ – you need first to consider grooming a management team and incentivising them with equity and share options. Perhaps you and the team are growing the company to an intended exit by sale. What though if you should die in harness? Can life cover and cross option provide the answer for you too?

In these circumstances a keyman policy with the company as recipient of the cash may be better and simpler. A cross option agreement can then be entered into by you (on behalf of your estate) to give your management team the right to initiate a buy-back of your shares on your death.

Practical issues

You may find that the cost of life cover particularly if you are thinking of putting these arrangements in place in your late 50s or 60s (or if your health is not good) could be prohibitive.

You might find that setting affordable life cover that is fair to your family in terms of the potential value of the company is impossible. Perhaps you and they have made very real sacrifices and sense that a future significant rise in value (which could not be insured economically) is just around the corner.

There are no right and wrong answers here. What you need to do is consider all the issues carefully with guidance from experienced professional advisers who know the alternatives and the pitfalls.

The Devil can be in the detail

Even for the standard 50/50 company there may be the possibility of additional shareholders. The existence of employee share options, that could be exercised ahead of the pay out on the policy can be an additional complicating factor.

So the trust arrangements need to be carefully considered. A policy that links the proceeds to the percentage shareholdings of the survivors may provide the flexibility that is needed. A number of life companies have standard trust clauses that work in this way and that can be used as a template.

You will want a good and experienced independent financial adviser to work with your solicitor and tax adviser.

Legal drafting

Whichever route is chosen the Articles of Association and any Shareholders’ Agreement will need to be reviewed to ensure that the life policy and option arrangements are consistent with the constitution of the company and the share transfer provisions.

If you’d like further information please contact us by phone on 0845 868 0962, or by email: james.hunt@everymanlegal.com. We’ll be very happy to give you help and advice with this and other related subjects.