While many SME directors die unexpectedly every year, surveys put the figure who have comprehensive business succession plans in place as low as 8%.

This is a big mistake. The earlier you begin business succession planning, the better. Leave everything to chance and there could be devastating consequences not just for your loved ones and beneficiaries in general, but also for your fellow directors.

Here’s an unhappy scenario, but one that bears scrutiny. A male director owns 49% of his SME’s shares; his female friend and co-founder holds the remaining 51% stake. Sadly, the minority shareholder dies suddenly – and his family members and co-director discover there was no plan in place to handle that eventuality.

This puts additional stress on the shoulders of everyone involved, even as they deal with the grief of his passing, and the problems also begin to affect the rest of the business.

Here are some of the reasons why such a lack of business succession planning could leave your legatees in a difficult position:

Keeping the firm going – While the surviving director in our scenario still maintains majority control, she now has the headache of accommodating the new 49% shareholders. Often, this is a direct family member of the director who passed away. They usually have little to no experience of the business, or the market in which it operates.

At best, this situation takes time and negotiation to resolve, perhaps shoehorning the new director into a position no party wants. At worst, it can cause strife – if, for example, the majority shareholder begrudges their new business partner an almost equal stake in the business for minimal input. It has been known for major shareholders to decide not to distribute dividends in such circumstances, causing further pain.

Trust in the process – One of the most regular oversights by company directors is not writing a business trust into their will. To qualify for 100% business property relief, shares of a business intended to be a going concern after a director’s death must pass via the “legacy” clause in the will to a specific beneficiary, as per S39A Inheritance Tax Act 1984. That specific beneficiary should be a trust.

If the assets are left via the “residue” clause the relief would be shared against the whole estate, which would otherwise be exempt due to benefiting other exemptions such as spousal or charity exemptions.

Not only can this give the shares 100% exemption after someone passes, it can also help future-proof against other issues such as divorce, inheritance tax and a widow/widower’s remarriage after death. This significantly improves the sustainability of the business across generations.

Don’t get cross, get cross-option – How will the deceased shareholder’s family and the company’s other shareholders be fairly compensated for their relative stake in the business? This is a highly complex area, but has a relatively simple, satisfactory and water-tight solution – a cross-option agreement – if you get the right advice.

After a director’s death, their shares should initially pass into a business trust – the beneficiaries of which are usually the late director’s family members. Meanwhile, the surviving director benefits from a life insurance pay-out – if a policy was in place – that is paid into a shareholder protection trust. But if the wrong life insurance policy was bought, the deceased director’s shares are effectively cancelled, and their value lost.

With a cross-option agreement the surviving shareholder can instead use the shareholder protection trust funds to buy the shares from the business trust. The family of the late director is compensated, no longer needs to worry about the shares, and the surviving director can realise the full value. Usually, this happens when they eventually exit. If the steps have been correctly followed – with the business succession plan firmly in place before the director died – this can have a big bearing on aspects of taxation such as Business Asset Disposal Relief and Business Property Relief working in the survivor’s favour.

For sure, business succession planning is a minefield. The main thing to take away is that it’s never too early to plan – but it can be too late to leave a consolatory, not complex legacy.

Whatever the stage of your business, it’s crucial to take a step back and consider the requirements of the company going forward should the worst happen. ADL helps scores of directors plan for the future, balancing your current lifestyle needs with ongoing considerations as the firm grows: from setting up in multiple markets, to rolling out benefits that keep employees engaged, always focusing a firm eye on the future.

You can find out more by watching this video. For a free initial hour-long consultation on succession planning for your business, where we’ll discuss in depth your current situation and potential future scenarios and solutions, please contact ADL Estate Planning today.

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