When a person owns stock in a closely-held corporation, they are often one of a limited number of shareholders. If a shareholder of a closely held corporation dies, there is often no legal effect on a closely-held corporation. However, some real and practical consequences can have an adverse impact on the corporation to continue as a viable business without advanced planning.
Shareholder Death in a Closely Held Corporation
No legal effect on the life of the business is realized by the death of a shareholder. The deceased shareholder’s interest in the corporation passes on to heirs or beneficiaries. Often the corporation is still legally intact and is able to carry on with business affairs for a time. However, there are some very real practical consequences that can occur with the death of a shareholder that can have a serious impact on the corporation.
Without advanced planning, the loss of an important member of the management team can cause a serious setback to the business. Then, the deceased shareholder’s heirs may become active in the business. These heirs may not be qualified to run the business. The same heirs may choose to become inactive in the business but still look to the business for income. Finally, they may choose to sell their stock to another individual without any input from the other shareholders.
Problems When Heirs Who Become Active Shareholders
If the heirs were not active members of the business before the shareholder’s death, they may not be qualified to take an active role in the management of the business. With little quality contributions, they often expect the same share of the profits. This can lead to serious problems, especially depending on the ownership interest amount.
- Heirs as Active Majority Shareholders – If the heirs, as new owners, are in a position to dictate corporate policy, the minority shareholders may do a majority of the work for a minority of the profits.
- Heirs as Active Minority Shareholders – Heirs that own a minority interest, still have certain legal rights. This may interfere with sound business judgement if the heirs exercise those legal rights in order to receive more liberal treatment from the surviving majority shareholders which can negatively affect the business.
- Heirs as Active Equal Shareholders – If an heir is an equal shareholder, the surviving equal shareholder may be faced with running the business with an equal, but unqualified, owner. If decisions cannot be reached quickly and harmoniously, the corporation may become stagnate and be forced to liquidate.
Problems When Heirs Become Inactive Shareholders
Although beneficiaries or heirs of a deceased shareholder may not be active in the day to day business of the corporation, they still may have a demanding voice in corporate policy. A variety of problems can be created by these inactive heirs, including:
- Heirs as Inactive Majority Shareholders – With controlling interest, inactive heirs may declare financially-unsound dividends with their ability and power to select the board of directors. They may also determine corporate policy that under minds the business. The business may not be able to shoulder the full responsibility for managing the corporation, while dividing profits with shareholder’s who make no viable contribution to the business. In addition, if the heirs rely on the income from the corporation’s profits and the business declares insufficient dividends, the heirs may not be able to survive.
- Heirs as Inactive Minority Shareholders – If the needs of the heirs who own a minority interest in the corporation are not in line with the actions taken by the majority shareholders who manage the corporation, then bickering, dissension, or impaired business progress can lead to a devastating shareholders’ suit.
- Heirs as Inactive Equal Shareholders – When a corporation has two equal shareholders, it is usually operated as a partnership with both shareholders splitting the workload and profits equally. If the surviving equal shareholder is not able to run the business alone, will the inactive heirs be willing to forgo part of their profit income in order for the business to survive?
There are just a few examples of problems that can arise when a proper plan is not in place before the death of any corporate shareholders in a closely-held corporation. Having a corporate insured stock redemption buy-sell plan in place will elevate many of these problems. If worked out beforehand, the transfer of stock will lead to a smooth transition from the deceased shareholder’s heirs to the remaining shareholders in the corporation.
The problems of unqualified heirs, in-fighting, or poor decisions that affect the corporation can be eliminated with careful planning. Many of the decisions that have to be made quickly after the death of a corporate shareholder can be made well in advance of the shareholder’s death. These decisions will cause less confusion and chaos when the time for the transfer to the heirs comes.
Those who are considering a corporate insured stock redemption buy-sell plan should be working with a corporate attorney or financial planning expert who can guide them through the decisions and issues that can arise when a plan is not in place. A majority corporate shareholder, especially one in a closely-held corporation, has a duty to the company to have arrangements in place to ensure that the transition is a smooth one.
There are many benefits of having a corporate insured stock redemption buy-sell plan. Every shareholder should consider this type of arrangement and discuss their concerns and questions with a financial planner.