Without initial planning and consideration if a director or business partner dies the surviving directors could run the risk of the shares passing to someone with no interest in the company.
Shareholder protection is designed to provide a lump sum to the remaining shareholders, or the company, to enable them to purchase the shares from the deceased partner. In most companies shares will often pass to the husband or wife of the deceased who may have no interest in the business or the knowledge to take over the roll.
With shareholder protection in place, the shareholding can be purchased giving the surviving spouse or partner the monetary value of their holding. In this way the remaining shareholders can retain control and the deceased families receive financial compensation.
Why protect the shares of a director?
If a business partner dies without making specific provisions for their share of the business their interest in the company will usually pass to their estate. The family then has two alternatives
- A member of the family could take over the deceased’s position as a partner.
- The family could realise the value of the business interest by selling it.
Neither of these is problem-free. If a member of the family takes over the deceased’s position as a partner there is no guarantee that he or she will be able to make any contribution to the business. In some cases their presence could be detrimental.
A sleeping partner who is not involved but is entitled to a share of the profits may be a huge burden to the remaining partners. Also the family may be unhappy to be in a position where they have no effective control over the profits which they may be relying on for income.
If the interest is sold the remaining partners may find themselves working with an unwelcome new partner, or indeed there may be no natural buyers in which case financial problems may surface not only for the family but also for the business.
Shareholder protection policies are often set up in trust where each partner would request the protection policy be set up on their life under trust for the benefit of the other partners.
In such a case the other partners are likely to be appointed as trustees. In the event of a claim, the other partners as the beneficiaries of the trust would then have available the money to buy the seriously ill or deceased partner’s share of the company.