Most small companies involve a limited number of shareholders who normally hold the shares in their own name.
Let's assume that you have 4 shareholders each owning 25% of the company. The question arises what will happen if one of the shareholders passes away or is disabled.
If there is no formal agreement in place between the shareholders and the remaining shareholders do not have the necessary finds to buy out the family, this will lead to the remaining shareholders having a family or family member as their new co shareholder.
This scenario is unlikely to be good for the business, as the family are unlikely to have the necessary skills or interest to be an asset to the business. Arguments could break out over things like dividend pay outs. The result is that all parties lose out as the remaining shareholders are stuck with a shareholder they do not want and the late shareholders heirs receive no real value for their shares.
A simple solution is for all shareholders to sign a Buy and Sell agreement when they start the business. The agreement should compel the sale of a shareholders shares on death or disability.
The agreement compels the remaining shareholders to purchase the deceased or disabled shareholders shares. It is important that a value is put on the company at the outset and then revalued annually on receipt of the financial statements. In need the company’s auditor can assist with the valuation.
The big question is how do the remaining shareholders raise the necessary funds to buy out shares.
The cheapest way is through life assurance. The shareholders will own policies on each of the other shareholders lives.
On the death or disability of a shareholder the policy proceeds will pay out to the remaining shareholders, who will then use the proceeds to purchase the deceased shareholders shares from the estate in terms of the Buy and Sell agreement. In the event of disability the shares would be bought direct from disabled shareholder.
Finally it is important that the Buy and Sell agreement contains an objective definition of what will qualify as disability. It is normally linked to the definition contained in the life policy.
As long as certain requirements in the Estate Duty Act are complied with, the policies will be exempt from estate duty.
The three requirements for the policy to qualify are:
* The policy must be taken out by someone who on the date of death was a partner or co shareholder with the deceased.
* The purpose of the policy must have been to acquire the whole or part of the deceased person’s interest.
* The deceased person must not have paid any premiums on the policy on their life.
A Buy and Sell agreement between co shareholders in a company, funded by life insurance , is the most efficient way to ensure continuity of the company in the event of the death or disability of one of the shareholders.