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Accrual twist of fate

Throughout the articles in this series, I have looked at the key stages in formulating, presenting and implementing a share-purchase arrangement in a limited company, using Owl Sewerage Services Ltd as a worked example.

First, then, to summarise the last few articles. The first key points I have tried to stress revolved around comprehensive fact-finding to det- ermine which individuals should be participating in the share-purchase arrangement, either as future buyers or sellers, or both.

In particular, it must not be assumed that it is every shareholding should be included as future sellers nor every shareholder as a future buyer.

Often, in my experience, this in-depth questioning will be the first time that these people have considered the destination – actual or desirable – of their shares on their death.

I also noted that an alternative and oft-used title for this strategy – director share-purchase arrangements – is dangerously misleading as the “sellers” will all be shareholders (and perhaps not directors) whereas the pros- pective buyers could be either shareholders or buyers, or both.

From this fact-finding, I moved on to the valuation of the shareholding, stressing that it was in my view unacceptable to simply pluck a number out of the air so long as it seems acceptable to all the participants.

The company&#39s accountant should be asked to become involved and, after the first valuation (either by amount or by formula), a regular review (possibly as often as annually) should be considered to ensure its ongoing validity. Indeed, this regular review should not only cover the share price valuation but should also ensure that the strategy is amended on any change of desired participant(s) – for example, a new or a retiring shareholder or director.

Thence on to the funding of the purchase, which, unless the participants have or are likely to have the available resources personally, will usually be best achieved by the use of appropriate insurance policies. “Appropriate”, here, has relevance to the type of policy (for example, term or whole of life) and the way it is written (single or joint life, life of another, whether or not in trust, etc).

An additional important aspect is the way in which premiums under the policies are to be paid – for example, whether the total premiums should be met equally by all participants (not usually the best way, I suggested) or in some proportionate way linked to each individual&#39s likely benefit.

This part of the strategy is, of course, where the financial adviser plays the greatest role but I also noted our preferred involvement as a central co-ordinating role between the different professionals, bringing us on to the involvement of the company&#39s solicitor.

The final aspect of the share-purchase arrangement is the legal agreement governing all of the above aspects, and more, noting for example whether the future transfer of shares will take place under a buy/sell or a double-option agreement.

Overall, then, a combination of good factfinding, a structured approach to the recommendation and implementation and the close involvement of the company&#39s other professional advisers.

But what of the alternative strategy I briefly mentioned above? Advisers wanting to ensure they genuinely give the most suitable advice for a company&#39s need must consider the possible merits of effecting a company share-purchase arrangement rather than an individual share purchase arrangement.

I intend to return to this subject in articles at some stage in the future as complex issues surround this alternative and the comparison with individual share purchase but I will content myself for now with briefly noting its outline features.

The main, and obvious, distinction is that, within a company share-purchase arrangement, the buyer of a deceased&#39s holding is the company itself, not the surviving individual participants. The company then, in effect, cancels the recently purchased shares, leaving the survivors with the same number of shares they held previously, but now representing a greater proportion of the total shares in issue which, of course, has been reduced following the company&#39s purchase and cancellation.

Any funding for this purchase must therefore be provided to the company, not the individuals, with similar considerations relating to payment of premiums and the participants in the legal agreement.

Whatever the perceived merits of each alternative, particular attention should be paid to strict rules and tax implications relating to the purchase by a company of its own shares.

Attention should also be paid to the relative inflexibility of company share purchase where it is desired to keep one or more of the individual participants out of the arrangement either as a prospective seller (that is, on death) or buyer (as a survivor).

Company share-purchase arrangements find it difficult not to include everyone in the net effect of a transfer of an individual&#39s shares.

Finally, and again with only time to touch on a subject I intend to return to in later articles, a few words about a similar strategy for partnerships. I say “similar” in rather a loose sense, even though during my early days in financial services I was “taught” that a strategy often known as partnership share protection was exactly the same as “director share purchase”, but for partnership shares not company shares. This is far too simplistic for a number of reasons, a couple of which I note below.

First, although not necessarily the most important, is that many partnerships have in their agreement (although many or most partnerships have no agreement at all, we are aware) a clause known as automatic accrual which, fundamentally, states that on the death of one of the partners his or her interest in the partnership will automatically accrue (or pass, to use more simple terminology) to the surviving partners, often without payment to the deceased&#39s beneficiaries.

Thus what might be, or appear to be, a valuable asset while the individual is still alive (that is, a share in a profitable partnership) cannot be passed to his nominated beneficiaries on his death. This clause can most frequently be found in professional partnerships such as accountants, solicitors and general practitioners where historically unqualified individuals may not have a proportional interest in the firm.

Where the automatic accrual clause exists, therefore, the financial need on a partner&#39s death is not towards the surviving proprietors, as with share purchase for a company, but towards the deceased&#39s spouse, partner or other dependants. In other words, any life insurance policy effected for this purpose must take this into account.

But that is not the end of the story, as many partners have a loan account in the partnership built up over the years perhaps by capital introduced to the firm or by the foregoing of some previous financial right such as part of salary or profit share.

This loan account will usually be repayable by the partnership to the deceased&#39s estate immediately on death, unlike a director&#39s loan account in a company, and it can frequently be easily surmised that this liability from the partnership might appropriately be covered by a life insurance policy.

In conclusion to this series of articles but introducing the subject for some future date, advisers must be aware not only of the type of share-purchase arrangement discussed in this series of articles but also of its near equivalents.

Next time, then, back on to sex and sexuality with a look at the latest and important pension developments.

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