This may seem like a very morbid subject to bring up with the other founders when you are discussing terms in a shareholders agreement, but as the (paraphrased) saying goes “death and taxes are certain”.
Unexpected death does happen, and as with any event that changes control of the company, you should consider what would happen. We assume that we are not planning in case of your death.
Like any property, who inherits the shares depends on the last will and testament of the person who has died. The legal term for a person who inherits is a “beneficiary”.
If there is no will, “rules of intestacy” decide who inherits. Generally, a wife or husband is the first person in line to inherit. If that is not possible, then children are next in line. Children under 18 can’t technically inherit – property is passed into trust on their behalf and managed by the executors of the will or someone else.
What you need to plan for is control moving to someone who may be inappropriate to deal with it. That may be anyone who cannot bring into the company the same skills as the person who has died, or it may be particular types of people such as young adults who may not yet be experienced enough to make business decisions, or a particular person, such as the husband of your co-founder who has always objected to the business.
It might also be a complete outsider. If the person who inherits does not want to be a shareholder, he or she may sell to someone else.
The ways of doing this are:
- limiting the rights of any new shareholder to make certain decisions about certain matters
- defining death as an event on which other shareholders have a right to buy the shares (similar to a right of first refusal)
Limiting the rights of a new shareholder is limited itself. Firstly, you cannot override the statutory rights of any shareholder. Secondly, the incoming shareholder may be able to deem the limitations “unfair” if they don’t end after a reasonable amount of time. A reasonable amount of time may not be enough to protect the company.
Defining a right to buy is generally preferable. You need to set out how the offer price should be calculated and who should have the right.
It could be the company that buys back the shares (in which case, all shareholders benefit in the proportions of their shares) or it could be individuals who have the right to buy a proportion no larger than their current proportional shareholding in the company.
Financing the purchase might be a concern. The buyers may not have the cash to hand. In which case, they could be given an extended time to pay.
Another alternative possibility is that there could additionally be a right that is triggered on death that allows the beneficiaries to buy the shares of the other founders (perhaps if none of the founders wants to, or can, buy out the beneficiaries). This may work particularly well if the shareholder who has died was a majority owner.
The great thing about such a right is that it can be backed by a life insurance policy (perhaps even paid by the company as an employment benefit) to provide the money required to do so.
Of course, having a “reversed” right isn’t for everyone. If your start-up has been your life for several years, you may not be happy to sell. However, you should consider whether the alternative of having someone else making decisions about your business is any better.
When considering what to cover in your shareholders agreement, do consider the unexpected. You need contingency plans for what happens to high level control, as well as what would change on a day-to-day basis from an operational point of view.