What happens to your business shares when a shareholder dies?

What happens to your business shares when a shareholder dies?

Lydia Sevenoaks, Corporate

Most business owners spend plenty of time thinking about how shares can be bought, sold or transferred. Far fewer consider what happens when a shareholder dies.

It isn't an easy subject to think about, but getting it wrong can create uncertainty for families, surviving shareholders and the business itself. Understanding what happens to shares after a shareholder's death – and planning ahead – can help avoid unnecessary disruption. A common misconception is that a shareholder’s shares automatically pass to the beneficiaries named in their will. In reality, there is usually an important legal process before that happens.

Understanding how it works can help avoid complications and ensure the business can continue operating as smoothly as possible.

Who owns the shares after a shareholder dies?

When a shareholder dies, their shares form part of their estate.

The people responsible for administering the estate - the executors named in the will, or administrators where there is no will -become entitled to deal with those shares.

This often comes as a surprise. Beneficiaries do not automatically become shareholders. Instead, the executors are responsible for dealing with the shares as part of the estate administration before ownership can pass to beneficiaries or another purchaser.

Why a transmission isn’t the same as a share transfer

One legal distinction that is often overlooked is the difference between a share transfer and a transmission.

A transfer occurs when a living shareholder voluntarily transfers shares to another person.

A transmission happens automatically by operation of law, including following the death of a shareholder.

Although this may seem like a technical legal distinction, it can have important practical consequences. A company's articles of association may treat transmissions differently from voluntary share transfers, meaning rights of pre-emption that apply to share transfers do not necessarily apply when shares pass to executors following a shareholder's death.

This can have a significant impact on who ultimately becomes a shareholder and whether the remaining shareholders have any control over the process.

What do the executors need to do?

Before the company can update its records, the executors will usually produce evidence that they have authority to act. Depending on the circumstances, that may involve a grant of probate, together with any other relevant documentation.

Once the company is satisfied, it can recognise the executors' entitlement to deal with the shares.

The executors must then decide, in accordance with the will (or the intestacy rules where there is no will), whether the shares should:

• Remin within the estate
• Be transferred to one or more beneficiaries
• Be sold

The right approach will depend on the terms of the will, the circumstances of the estate and the nature of the business.

Why your articles of association matter

Every situation is different, but the starting point should always be the company's articles of association and any shareholders' agreement.

These documents may contain provisions covering:

• The rights of personal representatives
• Compulsory transfers
• Share valuation mechanisms;
• Restrictions on ownership
• Procedures following the death of a shareholder

In our experience, many private companies are still operating under standard or historic articles that were adopted when the company was incorporated and have never been reviewed.

As businesses grow, ownership changes and family circumstances evolve, those documents may no longer reflect what the shareholders actually want to happen.

A simple review now could prevent significant uncertainty in the future.

The impact on your business

The legal process is often only one part of the challenge.

A shareholder's death can fundamentally alter the balance of ownership and control within a business almost overnight, particularly where a deceased shareholder was also a director, key decision-maker or held a significant proportion of the shares. The impact can be especially significant where there is only a small number of shareholders or the company operates on a 50:50 ownership basis.

Questions that frequently arise include:

• Who will make decisions going forward?
• Should beneficiaries become shareholders?
• What if some beneficiaries are active in the business and others are not?
• Is now the right time to review the company's ownership structure?

These are often commercial and personal questions as much as legal ones. Thinking about them in advance can help minimise uncertainty, protect the future of the business and make an already difficult situation much easier to manage.

How cross-option agreements can protect your business

Many businesses choose to put shareholder protection arrangements in place before they are ever needed.
One solution is a cross-option agreement supported by life insurance.

These arrangements provide a clear mechanism for surviving shareholders to acquire the deceased shareholder's shares, while ensuring the estate receives fair market value.

Without this type of planning, surviving shareholders may wish to retain control of the business but lack the personal funds to buy the shares Equally, the deceased shareholder's family may inherit a valuable shareholding but have no straightforward way for realising its value.

When combined with life insurance, a cross-option agreement can provide certainty for everyone involved. Insurance proceeds can fund the purchase, allowing the surviving shareholders to retain ownership and control of the business, while providing cash to the estate instead of an illiquid shareholding.

Although every business is different, , these arrangements are usually much easier to put in place before they are ever needed than after a shareholder has died.

Planning ahead

No one likes discussing death or succession planning, but having the right arrangements in place, particularly for owner-managed businesses, can make an extremely difficult situation much easier for everyone involved.

For owner-managed businesses, it is worth asking a few simple questions:

• Are our articles of association still fit for purpose?
• Do we have an up-to-date shareholders' agreement?
• What would happen if one of our shareholders died unexpectedly?
• Would the remaining shareholders be able to acquire those shares?
• Does our succession plan still reflect how we want the business to operate?

The best time to consider these issues is long before they become relevant.

Ultimately, this isn't just about who inherits the shares. It's about protecting the future of the business and providing certainty for everyone involved.

If you'd like to review your company's articles of association, shareholders' agreement or wider succession planning arrangements, our Corporate Team can help you put the right protections in place for the future. Get in touch to find out more.