Death of a founder = failure of the business?

Business Insights

Death is a traumatic event for the deceased's family, friends and those involved in their business. The untimely death of business owner or founder can leave a business in shambles. Combined with a lack of succession planning or inadequate planning this can have significant unintended repercussions. Recent studies suggest that a founding entrepreneur's death wipes out, on average, 60% of a firm's sales and cuts jobs by roughly 17%. Also, these companies have a 20% lower survival rate two years after the founder's death compared to similar firms where the entrepreneur is still alive. A recent Legal & General survey which found that 59% of businesses believed that they would have to stop trading in less than a year after the death or critical illness of a key individual.

Most business owners are motivated by the idea of building something with an enduring value and creating a lasting legacy for future generations. However, many businesses fail to spend enough time considering what the future will look like once the founders are no longer involved. Companies and businesses that are family owned/controlled may find that the deceased's shares are transferred outside of the family. Alternatively, it may result in family members such as the deceased shareholder's widow suddenly having a majority ownership of a company which they have no desire or experience to run. A founder's death can impact workers' overall performance because the founder likely played an imperative role in holding the company together.

What happens if there's no succession plan?

Failure to plan for business succession is a common oversight by many business owners. Unfortunately, creating a succession plan is often not high-priority for start-ups and longer-term businesses may put off succession planning because a founder's death seems unlikely and other pressing issues seem more crucial.

Not having a succession plan can throw a business into chaos with challenges like the following:

  • Power struggles: Without a succession plan, companies will likely see power struggles for who takes over

  • Loss of direction: Succession fights and related challenges can distract from a company's direction, potentially halting growth

  • Employee loss: The chaos of a business thrust into succession challenges can cause valued employees to leave

  • Loss of the founder's knowledge: A founder likely has intimate knowledge of the business, its operations and its customers. When they're unexpectedly taken away, that knowledge is lost and those relationships may never recover.

How to keep a business running after a founder dies

Ideally, a succession plan will set out the next steps after a founder dies.

A succession plan and business continuity plan are essential for keeping a business going on a founder's death. One of the reasons more businesses perhaps don't plan is because they wrongly assume that their families will automatically benefit from the value built up in the business in the event of their death, but that is not necessarily the case. Usually that shares in a company will pass to the estate of the deceased to be distributed in accordance with the Will or intestacy.

If a company's constitutional documents (articles of association and shareholders agreement) do not sufficiently deal with what happens on the death of a director and/or shareholder, this can provide practical difficulties which may prevent the company from carrying on business as usual. Moreover, if the founder was a sole director and sole shareholder, this brings it's own complications about how the company can continue to be run immediately after death.

There are a number of questions you should be thinking about:

  • What happens if a sole or majority shareholder dies?

  • Does the personal estate planning you have undertaken to date align with the aims of the business? You may have left company shares in your Will to particular individuals but you should think about how this works with your company's articles of association and any shareholders agreement that you may have in place

  • Do the company's articles of association/or shareholders agreement contain pre-emption rights on the transfer of shares?

  • If you want your shares to be transferred to your business partner or a family member when you die, how will the transferee fund the purchase of your shares?

  • Do you have suitable life insurance in place (such as shareholder protection insurance) to facilitate the funding of the transfer of your shares on death?

  • If you do have insurance, does this align with the relevant provisions in the company's articles of association?

Building blocks of Succession Planning

The best planning often starts with a comprehensive understanding of the financial landscape for any family and business. A clear understanding of the family dynamics, aspirations, priorities and medium and long-term goals is also needed.

  • A succession plan

Shareholders Agreement and articles for the company/business - It is imperative for business to have shareholder's agreement and articles which set out how the business is run. These documents make it much easier to move forward in an orderly manner. The agreements can set out the intention for the shares, any pre-emption rights and options to purchase the shares.

Separate to the shareholders agreement, you should consider a plan for how you anticipate the company to continue including leadership and management. This is focussing on the practical aspects of running the business including those more emotional decisions. The starting point is often dialogue within the family and creating expectations and formalising plans can avoid conflicts post death and any costly legal challenges. Transparent conversations and the right structures and documents in place ensure that family businesses and the families that run them will have clarity and certainty for the future.

  • Insurance

Founders can make their companies the beneficiaries of life insurance policies. Shareholder protection policies can allows shareholders to exercise an option for cash to be available to buy the shares in the business. Additionally, key person insurance can help replace lost revenue if a founder passes away. The business would pay the premium during the key person's life and then be eligible to collect a benefit after they die. This payment may be essential to continuing business operations.

  • Wills

Any business owner or shareholder should also ensure that they have an up to date Will which stipulates what should happen to their shares on death. They should check that the Will is consistent with the company's articles of association so there is no conflict or confusion. Business Property Relief trusts are a widely used estate planning tool to protect and preserve wealth and those should be considered when preparing the Will.

A founder's unexpected death will almost certainly have negative consequences for a company. However, if the business establishes a succession plan and takes other prudent steps, it can cushion the impact. The future of a family business hinges on effective succession planning. Once a plan is in place, it then needs to be reviewed regularly particularly at important life events.