Shareholder Protection Insurance
Help avoid disruption to your business if
a colleague were to die.
Shareholder Protection Insurance
Could you afford to buy the stock of a deceased shareholder in your private limited company, member of your limited liability partnership (LLP), or partnership partner?
If not, there can be serious repercussions for the future of your company. In this case, shareholder protection can assist you in preserving your company’s ownership.
What is Share Protection Insurance
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
Share protection can offer a lump amount to the surviving business owners in the event of a business owner’s death, diagnosis of a terminal illness (life expectancy less than 12 months), or a specific critical illness*.
This indicates that the lump payment could be used to assist in purchasing the dead partner’s, director’s, or member’s interest in the company if a legitimate claim is made within the term of the policy.
*If Critical Illness Cover is first selected at an additional expense.
Why Consider Share Protection Insurance
A business owner’s stake of the company may pass to their family if there is no share protection in place at the time of their death. This implies that the remaining business owners risk losing part, or maybe all, of their influence over the enterprise. The family may decide to get active in the continued management of the company or even sell their ownership stake to a rival.
What is a Cross-Option Agreement
The double option agreement, as it is also known, comprises of an option agreement between the firm owners that is supported by a policy held in trust. The option for the remaining business owners is to require the deceased’s estate to sell, and the alternative for the estate is to require the surviving business owners to buy within a certain time frame, for example, two months from the date of death. The opposite side must comply if either party exercised the choice.
In the amount to which they are already entitled to the remaining assets of the company, the remaining business owners will purchase the deceased business owners’ shares.
Although double option contracts are frequently used for life insurance, they are less suitable for severe or terminal illnesses, where a single option may be more suitable.
As an illustration, suppose there are four business owners, each owning 25% of the company.
The surviving business owners would each purchase a third of the deceased’s share after the first death. This implies that the ratio of remaining firm owners would remain the same.
The arrangement is not a legally enforceable contract for sale because the parties only have the option to buy, but it should still be possible for the estate of the deceased to qualify for business property relief for IHT calculations.
Each business owner will be required by the agreement to get and maintain a life insurance policy that will pay a lump payment to purchase their share. The other firm owners will serve as trustees of a separate share protection trust under which the insurance policy will be created.
The surviving shareholders may unwind in the knowledge that they will have the option to purchase, and the family who is left behind will have peace of mind knowing that there will be a willing buyer for whatever shares they may no longer want.
When a cross-option agreement is created, share protection is taken out. This protection can be reviewed on a regular basis as the business value changes over time.
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.
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.
You can reduce disruption at a challenging time for your business by making an eventual transfer of shares as orderly as possible.
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.
You can avoid costly buy-out capital and you won’t have to dip into your savings.
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
There will be no income tax owed on the proceeds in the event of a death claim because each insurance is qualifying or has no surrender value. Because the proceeds are paid to the original beneficial owners and the other business partners, there won’t be any CGT either.
However, if you sell your shares in the event of a successful critical illness or terminal illness insurance claim, your capital gains liability will be equal to the difference between the purchase price and the sale price of your shares. You would have achieved a capital gain if you received more money from your shares than you bought for them, and you might be required to pay capital gains tax.
There won’t be any Inheritance Tax (IHT) at the start of the Share Protection or when further premiums are paid if all Business Owners Participate. As stated in the Inheritance Act of 1984 (IHT 1984 S. 10), it can be argued that the agreement is a legitimate commercial transaction for full value with no gratuitous intent. The full consideration in this case is all the participating business owners. Since there has been no transfer of value, there will be no IHT upon death for the policy. Since 100% business property relief is applicable, there will be no IHT on the share protection on death.
Other Share Protection Agreements
The Buy & Sell Agreement
A contract between the owners stipulates that, upon retirement or death, the retiring owner or their estate must sell their share to the remaining owners, who then have to purchase it. The owners will buy a stake in the company equal to their part of the remaining ownership. The buy and sell technique may have drawbacks, such as the loss of Business Property Relief, which means that if an owner passes away, their portion of the company would be subject to Inheritance Tax.
Company Buyback
When a shareholder retires or passes away, the corporation agrees to purchase their shares under a contract that the shareholding directors enter into. The shares are then cancelled by the firm. The nominal value of the shares that are cancelled is deducted appropriately from the authorised share capital. The buyback must meet a variety of regulatory restrictions, which can make it a drawn-out and difficult procedure.
The Automatic Accrual Method
This is mostly employed in partnerships; in the event of a partner’s or member’s passing, the surviving partner’s or member’s share is immediately acquired by the surviving partner’s or member’s following a mutual agreement. Such an arrangement may include a life insurance policy to provide compensation to the deceased’s relatives.
How Much Shareholder Protection Insurance Do I Need?
Calculating how much funds the other shareholder partners would need to raise in order to acquire their coworkers’ ownership stake in the company is one method of determining how much shareholder protection insurance you need.
You might also choose to add Critical Illness Insurance to your shareholder protection cover policy, which can pay out if the covered individual is found to have a certain critical illness during the term of the policy. This needs to be added up front and will cost extra.
What Affects the Cost of Shareholder Protection Insurance?
As with other types of insurance, shareholder protection premiums are based on risk. The monthly amount will depend on a number of factors relevant to the insured person, including:
Their age.
Lifestyle and occupation.
Health status (and health history).
Smoking status.
Alcohol consumption.
Family medical history.
What Happens to Shareholder Protection if an Owner Leaves