As an entrepreneur it is best practice to plan for the unexpected. Shareholders do not always remain with the business indefinitely. A shareholder may leave, sell or pass away. As a result, a well-structured shareholders agreement can be useful when certain buy-out clauses are in place so that a business can make transitions from one shareholder to the next. However, if the shareholders agreement is not structured properly, without the input of buy-out clauses the business can suffer financial losses.

What Happens to the Shareholder’s Shares?
In many instances, when a shareholder passes away  or leaves to transfer his or her shares, a buy-out occurs. This buy-out is usually spelled out in the shareholders agreement that identifies who purchases the shares of the deceased shareholder. The purchase occurs between the designated buyer and the deceased shareholder’s estate or surviving family members. For example, if Fred holds 5% of the shares of company X and passes away. George, the designated buyer of company X, will buy Fred’s 5%. It should be noted that George will only buy the shares if the shareholders agreement indicates George as the designated buyer. Moreover, the shareholders agreement can stipulate that a  third party may also buy Fred’s shares. If there is no buy-out clauses in place, it is likely that Fred’s estate will own the 5% shares of company X. 

Other Alternatives
Under a common buy-out plan, a corporation will usually buy life insurance for all its shareholders. When a shareholder passes away, the remuneration of the insurance is used to buy back all the shares the deceased shareholder owned.

Takeaways 
The specific terms of a shareholders’ agreement should be analyzed by a tax professional to avoid unintended—and costly—consequences.

Author: Irbaz Wahab