Funding a share buyout after a co-owner dies: what shareholders need to know

Most shareholders believe this is already taken care of. There's usually a shareholder agreement somewhere, and perhaps an informal understanding that the remaining owners will buy the shares. But look more closely and an important detail is often missing: how the purchase will actually be paid for.

When a shareholder dies, their shares become part of their estate. They don't automatically pass to the other shareholders, who have to buy them. That's often where things grind to a halt.

Money is usually the sticking point

It's rarely a question of willingness. The surviving shareholders generally want to keep control, and the deceased's family usually wants a fair price for the shares rather than a role in the company.

The problem is cash. Private companies seldom have spare money sitting around. It's tied up in day-to-day running, invested in growth or held as a safety net. When the time comes to buy the shares, the funds simply aren't there.

Advisers then get involved, valuations are disputed and payment terms negotiated. The company might try to fund the purchase, putting pressure on working capital, or the shareholders might consider borrowing personally. Neither is ideal.

Timing causes problems too. Estates can take a while to settle, but families often need certainty sooner. That mismatch adds to the tension.

What tends to happen without a plan

Without a proper arrangement in place, things usually go one of a few ways:

• The family keeps the shares for longer than anyone wanted, giving someone with no involvement in the business a say in how it's run.
• The company uses its own funds to buy the shares, which can affect trading, especially in smaller businesses where cash flow is already tight.
• Negotiations drag on, with disagreements over value. One side wants a clean exit, while the other can't pay the asking price without hurting the business.

None of these are unusual. They're what normally happens when there's no way of funding the purchase.

How shareholder protection works

This is where shareholder protection comes in, although it's often misunderstood. It brings together two elements: an insurance policy and a legal agreement.

The insurance provides the money. The legal agreement, usually a cross-option agreement, gives the right for the shares to be bought and sold.

The cross-option agreement is central. It lets the surviving shareholders buy the shares and the estate sell them, based on a valuation method agreed in advance, so there's no need to negotiate everything from the beginning.

Set up properly, the process is simple. A shareholder dies, the policy pays out and the remaining shareholders use the money to buy the shares from the estate. There's no rush to find cash and no lengthy dispute about whether a sale should go ahead.

More than a legal technicality

It's tempting to see this as a minor legal point, but it's really about who controls the business and what the family receives.

Even a well-written agreement can fall down without funding behind it. A clause stating that shares "should be offered" is of little use if no one can afford to buy them. With funding in place, the agreement can actually be carried out. The business keeps ownership where it was meant to be, and the family receives cash at a difficult time.

HMRC guidance also covers how shares are treated within an estate, which is relevant when considering how ownership passes on death (GOV.UK).

An example

A company has four shareholders, each owning 25%. It's profitable, but most of its cash is reinvested.

One shareholder dies and their shares pass to their spouse, who isn't involved in the company, doesn't want to be, and needs financial security.

The other three want to buy the shares and avoid outside ownership or lengthy negotiations. However, they don't have the money personally, and taking that much cash out of the business would affect its operations.

Without shareholder protection, the process becomes long and stressful, with debates over valuation and payment terms. With it, the policy pays out based on an agreed value, the remaining shareholders buy the shares, the spouse receives a lump sum and the business carries on. It still needs to be set up properly, but it works.

A separate issue that often gets confused

Directors frequently look at relevant life insurance for their own cover because it's tax-efficient. That protects the director's family. Shareholder protection protects the ownership of the business. They solve different problems.

A relevant life policy can provide a tax-efficient payout to a director's family, but it won't fund other shareholders buying the shares. The two are often mixed up, but the difference matters.

The question to ask

Hardly any business owner intends to leave their share of the company to someone who doesn't want it. Yet that's exactly what can happen when a shareholder dies without a funded plan.

So ask yourself: could the remaining shareholders buy the shares at a fair price without harming the business? If not, your arrangements aren't complete.

Shareholder protection is simple in principle. It puts money behind an agreement most shareholders assume will work, replacing reliance on goodwill with a plan that can actually be carried out.