Securing Your Legacy: Essential Considerations for Transferring Private Company Shares in Succession Planning

When it comes to succession planning, it is generally understood that having a will is highly recommended.  Taking the time to get a will in place ensures that your assets are distributed according to your wishes and ensures any potential for family disputes is minimized, providing peace of mind for you and your loved ones.

In most circumstances, for most types of property, transfer of property to your chosen beneficiary will be relatively straightforward.  Subject to obtaining authority from the court (in a process known as ‘confirmation’, your executor can take charge of your property and distribute it in terms of your will. However where part of your estate consists of shares in a private limited company, matters can be more complex.

While the law treats shares as your private property, there is a common misunderstanding that title to these can be passed entirely at the direction of the owner.  This is not necessarily the case. Where a privately owned company is part-owned by other shareholders, or has been run by business partners during the deceased’s lifetime, shareholders may feel it is  inappropriate for a third party, with no prior interest in the company, to acquire a significant stake in a business. For this reason it is usual for a shareholder’s right to transfer shares, including any transfer on death, to be subject to a number of restrictions.

The regulations governing transfer of shares will always be found in the articles of association – the company’s key constitutional document.  A company may also have a shareholders’ agreement in place.  This is a private agreement between some or all of the shareholders, regulating how the company will be run, and how certain key decisions will be made, and may include restrictions on share transfers.  In terms of succession planning, careful consideration will need to be given to these documents to consider how the shareholder’s wishes might be implemented.

The precise scope of restrictions will vary from company to company.  An important factor will be whether the company has adopted a ‘bespoke’ set of articles of association, or whether it operates under the default model articles which otherwise apply under the Companies Act 2006.  Some companies may permit free transfers to family members or family trusts (though not to other third parties); other companies may have a blanket restriction on any transfer of shares by a shareholder.  The following are some of the typical restrictions which can be found:

• Pre-emption rights:

These rights are not contained in the default model articles, however they are commonly found in bespoke articles of association.  These rights give existing shareholders the first opportunity to purchase shares before they are offered to any third parties, which would include beneficiaries under a will.

The price for these shares will typically be their fair market value at the time of the shareholder’s death. This valuation can be determined through various methods as, unlike companies listed on the stock exchange, there is no ready market for the sale of shares in a private company.  Typically the articles will specify that fair value should be determined by an independent valuer, acting according to set accounting criteria, or perhaps by reference to the company’s financial statements or other agreed-upon mechanisms.

 Pre-emption rights ensure that existing shareholders maintain control over who becomes a shareholder, though this mechanism does rely on the other shareholders having ready access to funds to exercise these rights. To the extent that the other shareholders fail to take up their pre-emption rights, the executor will usually be permitted to proceed to transfer the shares to the nominated beneficiary.

•  Approval requirements:

Bespoke articles or a shareholders’ agreement can specify that certain transfers of shares require approval from a majority or unanimous vote of the existing shareholders.  These documents may also make a transfer subject to the specific approval of key shareholders such as investors.

• Directors’ right to refuse transfers:

In some circumstances, the board of directors may have the power to block a transfer of shares to a beneficiary. The model articles give the directors the power to refuse to register the transfer of a share, though this power must be exercised for a proper purpose, in good faith, and in the company’s best interests.

Bespoke articles may also include this right, or may limit its exercise to certain specified circumstances.

• Other restrictions:

Shareholder agreements may also include specific restrictions on the transfer of shares, such as prohibiting transfers to competitors or limiting transfers to certain individuals or entities.

The practical implications of these issues are clear.  It is vital to account for any restrictions contained within the company’s articles of association, or shareholder’s agreement, when considering succession and estate planning. Discussions with other shareholders may be necessary and specialist legal advice should always be sought.