Stress can be all consuming
Issues for sole traders
When a sole trader dies, the business dies with them. The business’s assets will form part of the sole owner’s estate and pass on to beneficiaries under the terms of their will. If the owner has not made a will, the laws of intestacy will apply – in effect, the state lays down who the estate should pass to. If the estate is large enough (in the UK and over £325,000 in 2019/20, including the value of any homes, business and other assets) and is not left to a spouse or civil partner, inheritance tax (IHT) is payable on all assets above £325,000.
However two issues can arise:
• Having to pay the Inheritance Tax bill (IHT) - life assurance can be invaluable in this respect
• Passing on the business - perhaps to an employee or business partner - a suitably drafted Will should be organised for these purposes.
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Always ensure a Partnership Agreement is in force
Issues for partnerships
A partnership is a business owned by two or more people. Unless specific provision is made in the partnership agreement (and very many partnerships have no formal agreement), the partnership will cease on the death of a partner. When that happens, the deceased partner’s estate becomes entitled to their share of the business. • The remaining partner or partners pay the deceased partner’s estate a sum of money agreed to be the value of the deceased partner’s share. • The surviving partner or partners and the deceased partner’s beneficiary carry on in business together – perhaps with the new partner having little interest or skills in the business.
For example, John and Jane are in partnership and Jane dies. Jane’s sole beneficiary, her daughter Kylie, is keen for the business to continue, and so is John, who could not afford to buy out Kylie’s interest anyway. Unfortunately, Kylie is unable to play any active part in the business, and John resents having to split the partnership’s income with a sleeping partner who contributes nothing other than capital to the business.
The solution
Two main options are available to meet such needs, and are illustrated below using the example of a simple two partner business owned by A and B. (Other options are available, but are generally not as attractive):
• A double option agreement - Under this agreement, the surviving partner has the option to buy the share in the business from the deceased partner’s estate – in other words, they can make the estate sell the share. The deceased partner’s estate can also exercise an option to force the surviving partner to buy. There must be an agreed basis for valuing the business.Generally, each partner takes out a life insurance policy on their own life, written under trust to benefit the other partner. So if A dies, B can decide to buy out A’s share from the proceeds of the policy on A’s life. • Automatic accrual - On A’s death, the business passes automatically onto B. No buyout is involved. Instead A’s beneficiaries get the proceeds from a life insurance policy A took out on his or her own life, written in trust for his or her beneficiaries.
The end result of both solutions is that the remaining partner continues to run the business and the deceased partners’ beneficiaries receive a fair price. Without these arrangements, the business could be in danger and the beneficiaries might receive little or nothing.
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Angry Board members
Issues for limited companies
Companies continue after a shareholder’s death, but the basic succession issues are similar to those facing a partnership. The key is to make sure that the shares end up with the surviving shareholders and that the deceased shareholder’s family receive the monetary value of those shares in cash.
Generally, the deceased shareholder’s beneficiaries will want financial compensation in return for their shares, assuming that they do not plan to continue in the business.
The solution
A double or cross option agreement is often used for company shareholder succession planning.
If shareholder A dies, their beneficiaries can require the remaining shareholders to buy them out or the remaining shareholders can require the beneficiaries to sell their shares.
To provide the funds, each shareholder takes out an own life policy written under a special business trust to benefit the other shareholders.
Cross Option Agreement
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