I concentrated on the identification of the need for a DSP arrangement for companies in different situations and concluded by looking at the example of a company whose shareholding is split between two unrelated business partners – Helen who owns 95 per cent and Fred who owns 5 per cent.
I would like to conclude that although Fred’s beneficiaries might well desire a DSP arrangement with a commitment from Helen to buy Fred’s shares on his death, it is unlikely that Helen will be bothered as her shareholding already gives her almost total control of the company.
Similar considerations could apply even where the minority shareholder has a substantial interest of, say, 40 per cent. If the remaining shares are held by just one person, the 40 per cent interest could prove difficult to realise as the 60 per cent shareholding also gives control over the company. Thus, a DSP arrangement may be desirable, although by no means as obviously so as in the company in the example below.
In Company B, Mike and Mary each own 45 per cent of the shares, with Tony holding the remaining 10 per cent. Although Tony is a small minority shareholder, on his death, his shareholding, when added to either of the other two shareholders’ interest, will constitute a majority vote, assuming all shares carry voting rights.
Thus, Tony’s interest is potentially of exceptional value both to Mike and Mary, irrespective of the notional value of the shares as an asset.
Here, it might well be desirable to put in place a DSP arrangement to cover all the shareholders.
In determining the likely need for the installation of a DSP arrangement, consideration must therefore be given not only to the apparent financial value but also the strategic value of each shareholding.
Before assuming that a DSP arrangement should be recommended to a particular company and its director shareholders, the adviser should take note of the personal relationships between the directors and the desire of the directors to make provision for the sale of their shares on death or the desire of the other director shareholders to buy shares if any of their colleagues die.
This point is exemplified in Company B, whose situation I have outlined above. If Mary and Tony were happily married, they would control a majority of shares in the company and, if one of them were to die, leaving the shares to the other spouse, this 55 per cent control would remain in the family. There may in these circumstances be little or no reason to make provision for the sale or purchase of their shares on their death or retirement. The same consideration would apply if Mike and Mary had been married.
If this assessment of the married couple’s plans proves correct, it might be desirable to buy out the holding of the remaining unmarried shareholder and this must be open to discussion between the adviser and all shareholders.
I will look in future articles in much more depth at other example companies with different shareholdings, extending the discussion to issues such as the identity of appropriate people (or the company) to pay the premiums under the various life policies.
Frequently, surviving directors will want to buy the shares of the deceased shareholder because they may feel that they have at a moral obligation to the family of the deceased to buy the shares for a fair price. They may also want to retain ownership and control of the entire company share capital.
However, in other situations, it may be the case that the recipients of the shares may want to retain them. This could arise because the potential flow of future dividends seems attractive or they believe that the value of the shares may rise or because they may already be involved in the business in an executive or managerial capacity and want to remain so as part-proprietors.
The recipients may, on the other hand, prefer to sell the inherited shares on the open market. Such a transaction could be undesirable for the other shareholders in a private company as they may then find themselves with one or more co-owners they do not know and do not want.
To protect the surviving shareholders, a pre-emption clause may be present in the company’s articles, as I mentioned in my last article, or there may be the right to veto the introduction of a new shareholder.
Thus, an essential early stage in establishing the possible need or desire for a DSP arrangement is to discuss and agree with the directors their objectives – individually and combined – in the event of the death of any of them as regards who should receive a deceased’s shares and whether it is desired that these shares be offered to surviving shareholders.
Having agreed the shareholders’ objectives, the next steps may be first to agree the destination of the shares of any of the shareholders in the event of death, checking that there is no conflict with anything stated in the articles of association.
Next, a valuation basis for the shares should be agreed. The assistance and guidance of the company accountants should ideally be sought in this respect, as I will detail in my next article.
An integral part of an agreed DSP arrangement is then – obviously of interest to financial advisers – to arrange life insurance to enable the share transfer to be funded or otherwise establish that sufficient funds will be available at that time to enable the agreed price of the shares to be met.
Finally, an agreement should be proposed and accepted regarding the form of the arrangement so that there is a clear and written basis to what has been agreed and accepted by all the parties.
This agreement – which must also minimise the potential tax liability, of course – might take the form of a buy-and-sell agreement, a cross-option agreement (or double-option agreement) or an automatic accrual although this is normally appropriate only to partnerships rather than limited companies.
There is much more to discuss, then, about all these issues, starting with the valuation basis for the shares in my next article.