As covered in our previous blog posts, the loss of a key person to a business can be immensely traumatic and disruptive. This is most likely to be the case when a business loses a shareholder, such as a director or partner.
Over half of the nation’s small and medium-sized enterprises have left no instructions in a Will or any special arrangement regarding their shares.
1/3 of partnerships have not reviewed their partnership agreement since their business started.
1/3 of limited companies have not reviewed their articles of association since their business started.
When shareholder protection arrangements are correctly put in place, they can greatly assist directors/partners to maintain full control of the business at a difficult time. In the event of the death of a company director/partner, the arrangement could provide the surviving shareholders with sufficient funds to purchase the deceased shareholder’s interest in the company back from his/her estate.
There are many factors to take into account when making contingency plans for the death of a shareholder:
What would the value of each director/partner’s shareholding be in the event of their death?
Would surviving directors/partners have sufficient personal wealth to buy out a deceased director/partner’s share of the business?
Would creditors still be willing to lend money to the company immediately after the death of a director/partner?
Would assets need to be sold to raise funds to purchase the deceased’s share?
Without suitable protection in place, the deceased’s shareholding could be inherited by someone with no expertise or interest in running the business. This loss of control by the surviving shareholders could potentially send any well-thought-out succession planning arrangements out the window, along with having significant financial implications.
There are 2 main parts to a successful shareholder protection arrangement:
Life insurance policies, written in trust, to pay out the required funds upon a director/partner’s death;
Legal arrangements, to set out the plans for the sale/purchase of the shares upon a director/partner’s death.
A key stage of the arrangement is then deciding on how to value the shareholdings. Once a valuation strategy has been agreed upon, it is important that the values of the shares are reviewed on a regular basis, annually perhaps. It is therefore equally important that the protection policies are reviewed at the same time, to ensure that the sums assured are appropriate for the value of the shareholdings.
Where shareholders are of different ages and in different states of health, the premiums for their insurance policies can be vastly different. This can be further complicated by each shareholder owning different proportions of the business. Your financial adviser could assist in this scenario, by apportioning the cost of the premiums appropriately to each director, so that those who stand to benefit more from the arrangement can pay a higher premium than those least likely to benefit.
Policies will be arranged to pay out the sum assured in the event of a shareholder’s death, but it is also possible for the policy to pay out if they are diagnosed with a specified critical illness. Please refer to our previous blog article for more information about critical illness cover. Shareholder protection policies do not acquire a surrender value, nor do they have any cash-in value. If the premiums are paid and a successful claim is not made during the policy term, then the policy will expire without value.
Shareholder protection is an example of just one of the many areas that should be carefully considered when putting together a holistic financial plan for a business. If you are uncertain of your business’s financial future, it would be worthwhile contacting a financial adviser to discuss your options, and to identify the needs of both you and your business.