“We are four friends that started our own company a few years ago with each of us being equal shareholders. We are thankful that is has been going well with the business, but now that there is some money and equity in our company, we were wondering what would happen in the event that one of us passed away.”
As with any other asset, shares constitute an asset in your estate. Accordingly, in the event of the death of a shareholder, our law will generally result in the shares being transferred to the heirs of the shareholder upon his/her death. But this may have unintended consequences for the company and the remaining shareholders. Heirs may not have the necessary experience to run the company, may not be qualified, or may have no desire to hold shares in the company. At the same time the existing shareholders may also end up with an unplanned and unwanted new shareholder, which could have dire consequences for the future productive operation of the business.
A common practice is for the remaining shareholders to buy out the shares of the deceased shareholder. But what happens if the remaining shareholders do not have enough capital to buy-out the shares of the deceased shareholder or the heirs are unwilling to sell, leaving the heirs remaining as the successor in title to the shares or ultimately selling the shares to third parties? All of these options create room for uncertainty, risk and potential adverse consequences for the company.
The answer to avoid this is to rather plan ahead and prevent such uncertainty and risk arising upon the death of a shareholder. Determining how shares will be disposed of in the event of death is also good corporate governance. For this reason it is prudent for shareholders to draft a written shareholders agreement which contains all the necessary provisions relating to the disposition of shares in the event of death, including methods for the valuation of shares, the sale of such shares, pre-emptive rights between the shareholders, the procedure to be followed upon the death of a shareholder and even provisions regarding policies on the lives of the shareholders.
Having a shareholder’s agreement is the first step to planning for such eventualities. Like a will that may need updating from time to time, so too it is important to have a shareholder’s agreement periodically reviewed to ensure it is still appropriate and provides for the changed circumstances of your company. Particularly when there is a change in shareholding it is an important time to review the shareholders agreement and also ensure that it is compliant with prevailing law and the company’s memorandum of incorporation.
If you do not have a shareholder’s agreement in place between the shareholders, it would be advisable to consult with a commercial attorney as soon as possible to help advise on the appropriate provisions to include in a shareholder’s agreement.