You and your partners and shareholders founded the company and were the driving force behind its success. But there comes a time in every entrepreneur’s life when they have to take a step back – sometimes this is voluntary, sometimes it’s not.
With a lot of business – both small and large – rely heavily upon their founders to remain successful (think Elon Musk and Tesla and SpaceX). But have you ever considered what will happen if one of them had to step away from the business due to illness or death?
Aside from the obvious loss of a good friend, business partner and key player in the company, there might also be complications surrounding where the shares end up if a shareholder dies. In most cases, the shares will be treated like an asset of the deceased and go into their estate. Eventually, the shares will be transferred to the deceased’s heir(s). Now, this is where the problems present themselves.
Generally, 3 things can happen if you don’t have a well-structured succession plan – and none of them have a positive outcome:
The shares could end up in the hands of someone you don’t know through the probate process or through a sale. If you’ve come this far in business, you understand how important it is to know and get along with your business partners. Many businesses fail because of conflicts between co-founders. Any unresolved disagreements could cause the company to struggle financially.
The heir of those shares might not have the skill or experience needed to help in running the business. Again, this could lead to the company struggling and maybe even failing altogether.
The heir might want to sell the shares to get some quick cash. This could seriously devalue the company causing to be sold at way below its actual value. If you don’t have the funds to buy back the shares, they could end up in some 3rd party’s hands and you might face the same problems as outcome #1 & 2. This person may not have the right experience, may have a different vision for the business, or some other point of conflict that could hinder your company’s continuing operations.
So now that we’ve outlined the problem, let’s talk about what we can do to avoid this.
Business Succession Insurance
The main goal of this type of insurance policy is to make sure you have enough cash on hand to buy back the shares. It also helps you set up the legal framework that gives the remaining shareholders the rights to buy back shares from the deceased partner.
To spare you the legal details, the legal framework is set up using a shareholders agreement or buy-back agreement either between the shareholders (if there aren’t too many) or between the shareholders and the company.
The agreement basically allows the surviving shareholders to buy back the shares back at a fair price from the estate of the deceased shareholder with money provided by the insurance policy.