The scenario in many businesses which have two or more shareholders, is that if one of the shareholders is to die, the shares he owns are, through the process of liquidating his estate, handed on to someone else – his heir or heirs.
This might not be to the liking of the other shareholders, so to forestall any unforeseen effects, they agree (while everyone is alive and kicking) that in the event of the death of any of them, the others will buy the shares of the deceased. It is usually a non negotiable item; after all, who really wants “that woman” kicking around in AGMs asking awkward questions, and grinding away at that axe?
The event is insured by way of life policies owned by the other shareholders on the lives of one another. The arrangement is all good and well.
But what amount is insured for? Some training documents for the brokers actually call for using “an arbitrary value” as the business value. Then there are some other arrangements involving lose multiples of various outcomes.
If that seems like a recipe for dispute; well that’s because it often is. Why should Mrs Axe Grinder be paid for her late husband’s shares at a 30% discount to real value? In particular, why should she settle for that when her brother in law is a hotshot attorney who knows the Companies Act, even more particularly, has an intimate understanding of sections 163 and 165? You have probably guessed by now that those sections hold some magic; and they do: They provide all sorts of natural South African remedies for minority and other shareholders who feel they have been treated unfairly.
Conversely, what if the business is not worth quite as much as the life insurance person thinks it is, and the shareholders spend some years betting on a book at too high a price? Sure the money will be paid out, and it may be a very good deal for the deceased’s spouse, but perhaps the surviving shareholders think that it was all a bit rich, particularly when they are all young and fit, and he is fat, flourishing, and somewhat less than fit. They will have had to pay over the top on two accounts – the dead partner’s insurance was more expensive than theirs, and the business is not worth nearly what they have been paying for.
Just a thought…
We have many clients who have their business value reviewed on an annual basis, and in a way which allows for the value of the business to be decided fairly in the event of the mid term death or disability of a shareholder. So there is a defensible way of dealing with annual sales cycles, quiet times and peaks.
If you have partners, shareholders or investors for whom this would make a difference, and want to explore some easy way of making it happen for you, please drop me an email on email@example.com.