When starting a business, optimism, and enthusiasm often take centre stage. Partners embark on their venture with trust and shared vision, rarely considering what might happen if circumstances change. However, as businesses evolve, a dose of realism is essential—especially when it comes to protecting the future of the company and its shareholders.
A Shareholder Agreement (or Partnership Agreement for partnerships) serves as a safeguard, ensuring that unforeseen events—such as the death of a business owner—do not lead to unwanted complications.
What Happens Without a Shareholder Agreement?
Over the years, we’ve seen the immense value that shareholders and partners bring to a business when things run smoothly. However, without proper agreements in place, disputes can arise, and the absence of a structured plan can lead to:
- Unintended business partnerships – If a shareholder passes away, their shares may transfer to a spouse or family member, leaving the remaining partners in business with someone who may have no interest or expertise in the company.
- Financial strain on the business – Without protection in place, surviving shareholders may struggle to buy out the deceased’s share, potentially leading to business instability.
- Disputes over ownership and decision-making – A lack of clarity can lead to legal battles, disrupting operations and creating unnecessary stress.
How Shareholder Protection Works
Shareholder Protection is a simple yet effective solution, involving two key elements:
- Life Insurance in Trust – A policy is taken out on each shareholder’s life, with the proceeds held in trust for the other shareholders. This ensures that funds are immediately available to purchase the deceased’s shares without delay.
- Cross Option Agreement – This legally binding agreement ensures that in the event of a shareholder’s death, the insurance proceeds are used to buy their shares from their estate. This means:
- The deceased’s family receives a cash lump sum instead of shares they may not want or understand.
- The business retains control, avoiding unwanted external influence.
Why a Cross Option Agreement is Preferable
While some agreements (such as Buy/Sell Agreements) require automatic sale of shares upon death, a Cross Option Agreement provides flexibility. It allows surviving shareholders the option to purchase shares rather than a forced sale, reducing potential inheritance tax liabilities.
Keeping Valuations Up to Date
A key part of shareholder protection is ensuring that the business valuation remains fair and current. Regular valuations prevent discrepancies in payout amounts and ensure a smooth transition if shares need to be transferred.
Is a Shareholder Agreement Necessary?
While not legally required, a Shareholder Agreement is a crucial step in securing a business’s future. It provides financial certainty, protects shareholders and their families, and reduces the likelihood of costly disputes.If you want to ensure your business is protected against unforeseen circumstances, speak with one of our Wealth Strategists today. We can help review your existing arrangements or set up a Shareholder Protection Plan tailored to your business needs.
