The loss of a shareholder can present a serious problem to a UK limited company. Not only do you potentially lose the advice and direction of one of your owners, but also their equity.
Without a solid financial plan in place, a shareholder’s equity typically passes into their estate when they die. This estate, in turn, would usually pass onto the deceased’s family – who might well have no interest in your business, and might, therefore, decide to sell the shares to someone outside of your company.
To safeguard against this possible future, this is where considering shareholder protection insurance can be a good idea. In this short guide, we’ll be providing an overview of this type of insurance, how it works, and how you can start going about bringing it into your business plan.
Please note that this content is for information purposes only, and should not be taken as financial advice. To receive regulated, professional and tailored advice into your own wealth and financial situation, please speak to an independent financial adviser.
Shareholder Protection: An Overview
A mentioned above, when a shareholder dies without a shareholder protection agreement, their equity would typically pass to their family via their estate. Here, either the family could try to use the shares to influence the company in an unhelpful direction, or sell the shares to someone else who has a similar lack of interest or harmful agenda.
The other shareholders might want to prevent this by buying the deceased’s shares from the family. However, without adequate funds to buy the shares, the sale could not be completed. It is also possible that the other shareholders might have the required funds, but the family is unwilling to sell to them (perhaps because they think they could get a better deal elsewhere).
Shareholder protection is designed to remove all of these potential scenarios. Essentially, it sets up an agreement between all of the shareholders in your company – which outlines the process which is set in motion upon the death of a shareholder. The policy also ensures that funds are available to allow shareholders to buy the deceased’s shares.
This type of arrangement can work nicely for all of the major players involved. First of all, it gives the family of the deceased assurance that they will receive a lump sum from the shareholders and that they will not be stuck with a share which they might not be able to sell. Second of all, it gives the surviving shareholders more confidence and peace of mind, knowing that business can continue more or less as usual upon a shareholder’s death.
It’s worth noting, however, that shareholder protection does not need to only cover the potential death of a shareholder. You could get a policy which covers other scenarios, for instance, such as providing funds to buy out a shareholder if they are incapacitated by a debilitating illness.
For business directors and owners, one clear benefit of shareholder protection is the stability and sense of certainty it can bring to the business’s succession plan. This is ultimately good for cash flow, staff morale, customers and other important stakeholders in the business.
Types of insurance
It’s important to note that, broadly speaking, there are three types of shareholder protection which might be more or less suitable for your particular business. It’s important to discuss these options with your financial adviser, to determine which kind might be most appropriate for you.
The first type of insurance is typically called a “life of another policy”, and is often a good option for businesses with two shareholders. It usually involves bestowing each shareholder with their own policy. The premium will depend on a range of factors such as shareholders’ health and age. When a shareholder passes away, then their policy will pay out to the other business partner so they can then buy the shares.
The second type is similar in that each shareholder has their own policy, but all of them are written into a specific kind of business trust. If a shareholder passes away, then the lump sum from their policy is paid to the business and distributed amongst the shareholders.
The final approach one can take is for the business to buy a policy, pay the premiums, and receive a lump sum when a shareholder passes away.
In all cases, it’s important to talk to your financial adviser about setting up a “double option agreement” (i.e. a “cross option agreement”). This essentially sets up the required processes and mechanisms to allow the surviving shareholders to buy the deceased’s shares and outlines the precise amount that the deceased’s family will be entitled to.
At this point, you will likely have a range of questions – including how much you are likely to pay for stakeholder insurance. This entirely depends on your situation and goals, as well as the offers presented by different insurance companies. To get the best deal, we highly recommend that you consult with a financial adviser to ensure that you locate the best available options for your needs, and make an informed decision which gives you the cover you need.
You will also need to take taxes on the stakeholder agreements into account too when deciding on a stakeholder insurance strategy. For instance, in some situations an Income Tax liability might be incurred if the trust fund is one day reverted to the owner, should the latter cease to be an owner (e.g. due to retirement or resignation).
Again, speak to an adviser about the possible tax implications of your stakeholder agreement, as there might also be ramifications for Capital Gains Tax and Inheritance Tax.