COMPARE LIFE INSURANCE
STEPHEN RODDY
INSURANCE BROKER
SHAREHOLDER
PROTECTION
Shareholder protection allows business owners to buy shares back from any partner who is diagnosed with a critical or terminal illness, or dies. This policy helps surviving owners stay in control and minimises disruption to the business.
SHAREHOLDER PROTECTION UK
WHY SHAREHOLDERS PROTECTION MATTERS
Dealing with ownership in a company can be difficult in the event of an untimely death or illness.
A shareholder arrangement sets out how the shares should be valued and gives the surviving shareholders the right to buy the shares, or the outgoing shareholder the right to sell.
SETTING UP SHAREHOLDER PROTECTION
Each individual shareholder can take out separate cover for themselves (known as an ‘own life’ policy).
This insures them for a sum assured equivalent to the value of their company shares.
If they choose to, they can write this into trust to benefit their co-shareholders.
You may also need your shareholding clients to enter into an explicit agreement that if one of them dies,
the remaining shareholders can buy their shares from their personal representatives.
They can also agree that if one of them suffers a critical illness, the affected shareholder can choose to sell their share.
If they decide to do this, the remaining shareholders must buy it.
These are called double and single option agreements. There are dedicated specimen option agreements and a specimen business trust document. I cannot advise on whether putting a plan into a trust would be suitable for the client’s particular circumstances and would recommend that they take professional legal advice on the suitability of these specimen documents.
Any policies you set up must be aligned with the Articles of Association and the shareholders’ agreement.
There may also need to be a trust and/or buyback document in place, for them to be effective.
I CAN INDICATE THE VALUE OF YOUR BUSINESS USING A CALCULATION USED BY SOME OF THE BIG INSURERS, IT'S ADVISED THAT YOUR ACCOUNTANT VERIFIES ANY VALUATION.
HELP AVOID DISRUPTION TO YOUR BUSINESS IF A SHAREHOLDER WERE TO DIE
If a shareholder in your private limited company, member of your Limited Liability Partnership (LLP) or partner in your partnership were to die, could you afford to purchase their share of the business?
If not, there could be significant implications for the future of your business. Shareholder protection can help you protect the ownership of your business in this situation.
WHAT IS SHARE PROTECTION?
A share protection arrangement enables the surviving owners to purchase the deceased owner's share of the business from the deceased owner's estate and ensures that the deceased owner's dependants have a willing buyer and cash instead of a share of the business.
HOW DOES SHARE PROTECTION WORK
In the event of a business owner dying or being diagnosed with a terminal illness (life expectancy less than 12 months) or a specified critical illness*, share protection can provide a lump sum to the remaining business owners.
This means that if a valid claim is made during the length of the policy, the lump sum could be used to help purchase the deceased partner, shareholding director, or member’s interest in the business.
*If Critical Illness Cover is chosen at outset for an extra cost.
WHAT IS A CROSS OPTION AGREEMENT
Also known as double option agreement consists of option agreement between the business owners backed up by a policy under trust. The surviving business owners have the option that requires the deceased’s estate to sell and the estate has the corresponding option to require the surviving business owners to buy within a specified period for example this would be two months from the date of death. If either party exercised the option, the other party must comply.
The surviving business owners will buy the deceased business owners share in the proportion to which they are already entitled to the balance of the business.
While double option agreements are generally used for life cover, they are less appropriate for terminal illness or critical illness, where a single option may be more appropriate.
For example: there are four business owners, each has a 25% share of the business.
On the first death the surviving business owners would each buy one third of the deceased’s share. This means that the same ratio would be maintained between the surviving business owners.
Because the parties only have the option to buy, the agreement is not a binding contract for sale and so it should still be possible for representatives of the deceased to claim business property relief for IHT calculations.
The agreement will require that each business owner must take out and maintain a life policy to provide a lump sum to buy their share. The policy will be written under a special share protection trust with the other business owners also being trustees.
This offers peace of mind to the family left behind, as they know they will have a willing buyer of shares they may no longer want, and remaining shareholders can relax in the knowledge that they will have the option to purchase.
Share protection is taken out at the point of setting up a cross-option agreement, and can be reviewed regularly as the business value changes over time. We provide a specimen copy of the cross-option agreement as part of our Share Protection service.
If a business owner dies with no share protection in place, their share in the business may be passed onto their family. This means that the surviving business owners could lose control of a proportion of the business, or in some circumstances, all of it. The family may choose to become involved in the ongoing running of the business or could even sell their share to a competitor.
THE BENEFITS OF SHAREHOLDER PROTECTION INSURANCE
Losing a valuable shareholder, whether through illness or death, can have a destabilising effect on a company. Here are some advantages of taking out Share Protection to safeguard your business.
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You can stay in control of the business by preventing the shareholding from being inherited by an unwanted beneficiary, whose priorities may not align with yours.
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You can reduce disruption at a challenging time for your business by making an eventual transfer of shares as orderly as possible.
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You have the flexibility of coming to different agreements on how to manage the shares; for example, owners could buy shares back from a shareholder who’s diagnosed with a critical or terminal illness.
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You can avoid costly buy-out capital and you won’t have to dip into your savings.
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You can ensure there is greater transparency for the insured person’s beneficiaries as they’ll have a clearer picture of what they will receive for selling the shares to other shareholders.
TAX SITUATION
Because each policy is qualifying or has no surrender value, there will be no income tax liability on the proceeds in the event of a death claim. Neither will there be CGT, because the proceeds are payable to the original beneficial owners the other business partners.
However, in the event of a valid critical illness or terminal illness cover claim, if you sell your shares the capital gains liability will be the difference between the amount you bought them for and he amount you sell them for. If you receive more from your shares than you paid for them you would have made a capital gain and may need to pay Capital Gains tax.
If all the business owners take part in the share protection there will be no Inheritance Tax (IHT) at the outset or when further premiums are paid. This is because it can be claimed that the arrangement is a bona fide business transaction for full consideration with no gratuitous intent (Inheritance Act 1984) (IHT 1984 S 10) full consideration being the fact that all the business owners taking part. There will be no surrender IHT on the policy on death, since no transfer of value has happened. There will be no IHT on the share protection on death, because 100% business property relief applies.
SHARE
PROTECTION
6 OUT OF 10
BUSINESS OWNERS
Said they had no protection in place to cover the cost of purchasing shares should a business owner die
L&G 2018 Business Research