If the other owners or the family exercise their option, the other party must then comply and either buy or sell the shares.
This ensures continuity of ownership for the remaining owners, and that the family have a willing buyer and they receive a fair value.
This type of arrangement is known as shareholder or partnership protection.
Sean Dunlop, protection proposition manager at Scottish Widows, says that when passing on a business to the next generation it is important that the business retains as much value as possible and is resilient to financial vulnerability.
He adds: "Setting up a five-year renewable policy to cover the loss of profits of the death of a key person, to pay off any outstanding commercial and director loans and provide money to cover share purchase costs, is crucial to ensure that value is retained for the next generation."
But there may be other problems the business now faces. Any borrowing may need to be repaid.
Smart says: “The business may run into short-term profitability issues while it recruits and trains someone to take over the duties of the owner that has died. The business can take out insurance against the financial effects of losing a key person, known as key person cover.
“This would be taken out by the business on the life of the key person and provides the business with a lump sum should the key person die. It’s also possible to provide cover for a critical illness or to provide the business with an income in the event of temporary disability of the key person.”
In both cases it is important to make sure the right level of cover is put in place and that it is paid to the right person at the right time.
Key person insurance pays a sum of money to shield a business from the financial impact of a key individual dying or being out of action while they recover from a critical illness.
But it cannot be used by directors to buy the share of the business held by another shareholder in those same situations, which is where the shareholder protection comes in.
Shareholder protection pays a lump sum that can be used to buy shares from the family of a director who has died or, in the case of a critical illness, from the director who wants to sell their shares and leave the business because of their poor health.
Alison Esson, propositions manager at AIG Life, says it is something business directors really should think about, because a lack of succession plan can ruin their own financial legacy and the business they worked so hard to build.
