30 Nov 2018

Ensuring measures are in place could prove crucial in protecting your business.

The departure of Instagram founders Systrom and Krieger is a stark reminder of the potential conflict that can occur in fast-growing businesses and cause sudden departures. But sometimes, unexpected exits are driven by personal or tragic circumstances and these can cause some of the biggest problems for companies and their directors.

These situations may be out of anyone’s control, but despite the unknown, it is still possible for entrepreneurs to protect both their business and personal wealth from the unexpected.

Here we explain how:

Create a succession plan

Succession planning is rarely on founders’ radars, especially in the early stages of growing a business. The associated costs can be off-putting, but this is an investment which could prevent significant problems further down the line should the worst happen.

A succession plan should at least include a Will, stating what will happen to a founder’s shares should they die. It may be helpful for some details of this succession plan to be shared with fellow business owners, so they know who they could potentially be going into business with following inheritance of the shares. Co-founders will need to consider whether they would be happy to work with that person and if not, ensure there is sufficient funding or insurance in place to buy them out.

As part of the planning process, business owners should consider whether their shares will be subject to inheritance tax or whether the shares could benefit from relief. If tax is payable then consideration should be given to how the tax will be paid, without disrupting the business.

A Will can be simple, especially when the business is starting out, but as the company grows, it is worth reviewing as needs and circumstances will change. Expert legal advice should be obtained to ensure a founder, their family and business are all protected. Understanding the potential effect of corporate governance documents on a Will is unlikely to be provided from an ‘off the shelf product’ and could lead to expensive and inconvenient consequences. Professionals will ask important questions and explain the options available, including whether a trust could be useful and if so, how this will work in practice.

If there is no Will, then an estate including a founder’s shares (subject to any restrictions in the corporate governance documents), would pass according to the rules of intestacy, which could leave unanswered questions about who would benefit in these circumstances. More importantly, under these rules, if circumstances mean that a family has not survived a founder and there is no blood line, then their funds could be passed to the Crown.

Prepare for a break up

Nobody wants to think about a relationship breaking down, whether that’s in business or at home, but it’s a risk that all founders should consider and plan for. A change in personal circumstances could have a major impact on the business and see business owners lose a significant amount of control.

Even if someone is happily married, they should think about what would happen if they were to get divorced. In this situation, any business interests/ shares could form part of the “marital pot” which is available for division between the business owner and their spouse. No doubt any shares will be some of the most significant assets in the pot so it is worth putting measures in place to protect them.

It’s common for a shareholder to gift shares to a spouse for tax reasons, but founders should clarify what would happen to these shares on divorce or separation. It is possible to include certain clauses in the corporate governance documents which determine what happens to your shares in these circumstances. For example, any shares gifted to a spouse could automatically revert back to the founder or be offered to other shareholders, members, or partners in the business. Careful consideration needs to be given to the valuation mechanism adopted in such circumstances.

Without this protection, founders may have to spend a lot of time and money arguing over what should happen to the shares and the value to be attributed to them. There is also a risk of losing some control in the business together with the uncertainty that comes with that.

Consider a Lasting Power of Attorney (LPA)

It’s an uncomfortable subject, but losing physical or mental capacity is another important consideration for entrepreneurs. If anything happens to a business owner and they become unable to make a decision because they lack mental capacity, without the appropriate legal documentation no one can make a decision for them.

To protect a business owner, their family and business in this situation, an LPA can be put in place which enables founders to choose who can make decisions on their behalf in such circumstances. There are two different types of LPA, dealing with decisions for finance and property and also health and welfare. The property and finance LPA is key as it can also be used to make decisions in relation to shareholdings.

These are extremely useful documents as without the authority contained with the LPA, if a founder loses capacity following an accident or illness, someone would have to apply to the Court of Protection for a deputyship or other order. They would not have any control over who does this and it is both costly and time consuming in already stressful circumstances.

Losing a founder is a huge challenge for any fast-growing business, regardless of the circumstances. Although it’s not possible to plan for all eventualities, there are steps entrepreneurs and their fellow founders can take to mitigate against potential issues which could be detrimental to their company.

Planning for potentially negative or traumatic situations does not come naturally to most people but considering the impact of these from the outset will enable measures to be put in place which could prove crucial in protecting a company and its business owners in the future.

For further information or advice, please contact Sabrina Sears or Rachel Bevan.

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