Contingency Planning for Business Owners
Most business owners spend considerable time planning for growth, managing finances and protecting their company against commercial risks. However, one important question is often overlooked; what would happen if a director or major shareholder suddenly died or became unable to make decisions?
All limited companies, including family-owned businesses and small businesses, should consider having a contingency plan in place for these circumstances.
The unexpected death or incapacity of a key individual can affect everything from day-to-day payments to the ownership and control of the company. Without appropriate arrangements, surviving directors and family members may face difficult decisions at an already stressful time.
At AFG Law, our Private Client solicitors advise business owners, directors and shareholders on protecting their personal and commercial interests through Wills, Lasting Powers of Attorney, shareholder succession arrangements and tax-efficient estate planning.
Below, we explain four important steps to consider when creating a contingency plan for your business.
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What is business contingency planning?
Business contingency planning involves identifying potential risks that could disrupt a company's operations and putting arrangements in place to manage them.
A contingency plan might address a natural disaster, cyber attacks, data breaches or other unexpected events that affect essential business functions.
Many companies already have a business continuity or disaster recovery plan covering these operational risks. However, fewer have considered what would happen if a director or shareholder died or lost mental capacity.
This is an important part of risk management, particularly in owner-managed companies where a small number of individuals may control financial decisions, banking arrangements and company ownership.
While an operational recovery plan might explain how to restore computer systems following a cyber attack, a director succession plan addresses a different question. This is, who has the legal authority to make decisions if a key person is no longer able to act?
There are four steps every limited company should consider.
Step One: Make sure your shareholders' agreement deals with death and incapacity
A shareholders' agreement should clearly establish what happens if a business owner dies. For example, should the company have the option to buy back the deceased shareholder's shares? Alternatively, should the remaining shareholders have the opportunity to purchase them?
Without appropriate arrangements, the shares may pass under the deceased person's Will or the intestacy rules to their spouse, children or even a charity.
Depending on the company's Articles of Association and the rights attached to the shares, the beneficiaries may acquire voting rights or influence over the appointment of directors and other important company decisions.
Shares could also become divided between several family members, making decision-making more complicated.
This can create particular difficulties in family-owned businesses where some relatives work in the company while others have no involvement in its day-to-day management.
A properly drafted shareholders' agreement can establish how shares should be dealt with following a shareholder's death, including any options to purchase them and how their value should be determined.
The agreement should also be consistent with the company's articles of association and the shareholders' personal estate planning arrangements.
The aim is to provide certainty for the remaining owners while ensuring the deceased shareholder's family is treated appropriately.
Step Two: Insure the risk of a shareholder's death
Having an agreement allowing shares to be purchased is important, but the company or remaining shareholders must also consider how the purchase would be funded. For example, if a shareholder dies holding a substantial interest in the company, the surviving owners may wish to acquire those shares but lack sufficient available funds.
This is where shareholder protection insurance can play an important role. Depending on the arrangements, the company or shareholders may take out insurance designed to provide funds following the death of an insured shareholder.
Cross-option agreements may also be used to give the relevant parties options to buy or sell shares following a death.
Where a company buyback is proposed, the arrangements must comply with the relevant company law requirements. Company-funded insurance and shareholder-owned cross-insurance are different structures and should not be treated as interchangeable.
With appropriate legal and tax advice, these arrangements can help provide financial security for the deceased shareholder's family while allowing the business to continue under the remaining owners.
The structure of the insurance, the ownership of the policies and the treatment of the proceeds should be considered carefully. This is particularly important where inheritance tax reliefs may be available.
Step Three: Plan for a director losing mental capacity
Most people associate loss of mental capacity with long-term illnesses such as dementia. However, incapacity can also arise suddenly and may be temporary or of an unknown duration. For example, a director might suffer a serious accident, have a stroke or be placed in an induced coma.
Even a relatively short period of incapacity can create significant problems for a company. A director may be unable to authorise payments, sign cheques, approve transactions or participate in decisions required under the company's governance arrangements.
Where the business relies heavily on one individual, this can affect business continuity and prevent essential decisions from being made.
How can a Lasting Power of Attorney help?
A Property and Financial Affairs Lasting Power of Attorney (LPA) allows an individual to appoint trusted people to make certain financial decisions on their behalf. For business owners, this can be an important safeguard.
A director may appoint a family member to manage their personal property and financial affairs. They may also wish to appoint someone with relevant business experience, such as another director, to deal with appropriate business-related financial matters. In some circumstances, separate LPAs may be appropriate for personal and business affairs.
However, an LPA does not automatically allow an attorney to exercise the statutory powers of a company director or take over that person's office. The company's articles, shareholders' agreement and arrangements for appointing replacement directors must also be considered.
Each director should therefore review their personal and business arrangements to establish what authority would be available if they became incapacitated.
Our Lasting Power of Attorney solicitors can advise on preparing appropriate documents.
What about business pension schemes?
Incapacity can also create problems where a director acts as a trustee of a business pension scheme. If a pension trustee becomes unable to act, the scheme's trust documentation and relevant pension rules will determine how decisions can continue and whether a replacement trustee is required.
This is another area where planning ahead can help avoid unnecessary disruption. If someone has already lost mental capacity without appropriate arrangements in place, advice may also be required about an application to the Court of Protection to deal with their personal financial affairs.
Step Four: Make sure each director's estate planning is tax-efficient
Contingency planning should not stop at the company's legal documents. Each shareholder and director should also review their personal estate planning arrangements.
A Will should explain what happens to their assets following death and should be consistent with any shareholders' agreement.
For example, where an agreement provides for shares to be purchased following death, the Will should be prepared with those arrangements in mind.
Without coordinated planning, a shareholder's personal wishes may conflict with the arrangements intended to protect the company.
Inheritance tax and business interests
Certain business assets and shares may qualify for Business Property Relief from inheritance tax, subject to the applicable eligibility requirements, thresholds and rules. However, the availability of relief should never be assumed.
The nature of the business, the ownership structure and the terms of any arrangements for transferring shares can all affect the tax position.
Professional advice can help directors structure their Wills and succession arrangements to make appropriate use of the reliefs available.
Pensions, life assurance and death-in-service benefits
Directors should also consider how their pension nominations, life assurance policies and death-in-service benefits fit into their wider estate planning. These benefits may be governed by separate nomination forms, policy terms or trustee discretions rather than passing automatically under a Will.
Reviewing them together can help ensure the arrangements reflect the director's wishes and provide appropriate financial support for their family.
How does this fit into a wider business continuity plan?
Planning for the death or incapacity of a director should form part of the company's wider approach to risk management. A business continuity plan may identify key risks affecting staff, premises, technology, finances and leadership.
For example, the company may have an action plan for responding to cyber attacks, data breaches or a natural disaster. It may also maintain a disaster recovery strategy for restoring IT systems and other essential business functions.
However, these arrangements do not necessarily address the legal consequences of losing a director or major shareholder.
When identifying potential risks, directors should consider the specific risk posed by their own absence, including who would have authority to make financial and management decisions.
The arrangements should be regularly reviewed as the company grows, shareholders change or personal circumstances develop.
A contingency plan prepared several years ago may no longer be suitable if the ownership structure or management responsibilities have changed.
When should business owners put a contingency plan in place?
Ideally, contingency planning should begin well before a director approaches retirement or develops health problems. Unexpected events can affect business owners of any age, and leaving these arrangements until they become urgent can significantly limit the available options.
A good starting point is to review the company's existing shareholders' agreement, articles of association and insurance arrangements alongside each director's Will and Lasting Powers of Attorney.
This helps identify gaps and establish which legal documents or financial arrangements may need updating.
Contingency planning advice from AFG Law
At AFG Law, we advise both boards of directors and individual directors and their families on planning for the unexpected.
Our Private Client team includes solicitor David Carson, a member of STEP with more than 20 years' experience advising business owners on estate and succession planning.
We can assist with reviewing Wills, preparing Lasting Powers of Attorney, considering shareholder succession arrangements and advising on tax-efficient estate planning.
Whether you run a family-owned company or a business with several shareholders, we can help you consider what would happen if a key individual died or became unable to make decisions.
To discuss contingency planning for your business, contact AFG Law on 01204 377600, email privateclients@afglaw.co.uk or complete our online enquiry form. We have offices in Bolton and Bury and assist clients throughout England and Wales.