Have you considered what might happen to your business if a major shareholder died, and you did not have the funds to buy their shares? In the UK, shares owned by an individual form part of his/her estate when they die. These, along with their other assets, then pass down to their beneficiaries – typically family members – who may not have any experience, knowledge or interest in the affairs of your business.
This is where shareholder protection can help. Not only does it provide the funds needed to buy the shares in such a scenario, but it also provides an agreement between the parties that helps protect the interests of the remaining business owners. In this article, our team at Vesta Wealth explains how this type of business protection works, why owners should consider it and how to set it up.
How shareholder protection works
Shareholder protection is an insurance policy that pays out when the insured person dies. It can be taken out by the individual shareholders, or it can be taken out on behalf of the business. The lump sum amount is determined by calculating the value of the capital that remaining shareholders would need so they could buy the shares of a deceased shareholder.
A range of factors determine how much the policy costs (i.e. the monthly premiums) including the shareholder’s age, health and lifestyle factors such as smoking.
Quite often, shareholder protection also includes a ‘single option agreement’ which gives the shareholder the option to sell their shares if they are diagnosed with a critical illness.
This is different to a ‘double option agreement’, which requires the deceased shareholder’s representatives to sell the shares if the remaining shareholders wish to buy them. Likewise, if the deceased’s representatives wish to sell, then the remaining shareholders cannot refuse to buy. A double option agreement can benefit from Business Property Relief from inheritance tax (IHT) since it is not a binding sales agreement.
Why shareholder protection matters
In an extreme case, it is possible that a deceased shareholder’s shares could be inherited by someone who would harm your business. Perhaps they may want to pick up duties and responsibilities for which they are not qualified, or, they could sell the shares to another person who does not put the interests of your business first. Shareholder protection helps to stop this from happening.
Another benefit of shareholder protection is the peace of mind it offers. Whilst a death of a shareholder would no doubt be very disruptive, this policy could reduce a threat to the business finances, strategy or operations. The agreement enables a smooth transition of shares from the deceased’s estate to remaining shareholders and gives beneficiaries assurance that they would receive a guaranteed sum, rather than needing to keep shares they may not want.
How to set up shareholder protection
Setting up shareholder protection arrangements is often challenging. Gaining professional financial advice can help ensure you get the cover your business needs and helps prevent owners from falling into common mistakes. The first consideration, of course, is determining how much cover is needed from the policy. Here, it can help to work with your fellow business owners, accountant and financial planner to determine:
- The value of the shareholding.
- Whether the dividend yield needs to be a factor when calculating the policy.
- How net assets on the company balance sheet may influence the cover.
- Sustainable profit figures using an appropriate earnings ratio.
Before approaching protection providers, you will also need to be prepared with personal data about the shareholders e.g. age, health, lifestyle factors – as these will all have a big impact upon the premiums and risk assessment. This information needs to be up-to-date, accurate and completely honest to avoid a future situation where a provider may dispute a claim. Even small omissions or inaccuracies could lead to big problems later.
Rules to bear in mind
If you want to set up shareholder protection arrangements, then some key regulations must be followed. Firstly, any policy must be paid using taxed income i.e. it cannot be used as a means to deduct tax. It can be classed as a business expense, however. Secondly, the costs and benefits of any policy held by a business (not an individual) must be split evenly between the shareholders. This is the case even for minority shareholders. Thirdly, if you are concerned that any policy proceeds may not be used to buy remaining shares, then consider making a shareholder agreement. Another approach is to write the agreement into your articles of association if you are setting up your company at the same time as taking out a policy. Speak to your financial planner about which type of shareholder protection may be best for your needs e.g. own life plans, life of another plans or company-owned plans.
Invitation
If you would like to discuss your financial plan and retirement strategy, then we would love to hear from you. Get in touch with your Financial Planner here at Vesta Wealth in Cumbria, Teesside and across the North of England.
Reach us via:
t: 01228 210 137
This content is for information purposes only. It should not be taken as financial or investment advice. To receive personalised, regulated financial advice regarding your affairs please consult your Financial Planner here at Vesta Wealth in Cumbria, Teesside and across the North of England.