What is Shareholder Protection?
Shareholder Protection protects a business and its shareholders by making succession planning as smooth as possible should a company shareholder die or become critically ill.
It provides the necessary capital for the remaining shareholder(s) to buy the deceased’s share of the business.
The business can continue trading as normal whilst the deceased shareholder’s family can realise the value of their business interest.
More than half of businesses had no formal agreement to establish what would happen if a business owner died – Legal & General
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What Does Shareholder Protection Cover?
Shareholder Life Insurance
Should a shareholder die or suffer a terminal illness (diagnosed with less than 12 months to live) a shareholder protection policy would pay out a lump sum to the other shareholder(s).
Adding Critical Illness Cover to Shareholder Protection
Adding Critical Illness Cover enables the plan to pay out if the shareholder were to suffer a serious illness, such as cancer, heart attack or stroke.
A Cross-Option Agreement is set-up alongside Shareholder Protection which on death provides the option for the other shareholders to buy the shares (‘Call’ option) and the option for the deceased’s family to sell (‘Put’ Option).
Should the shareholder suffer a serious illnes only a ‘Put’ option exists, giving the shareholder who has suffered the critical illness the option to sell their shares to the other business owners but not the right for the business to buy the shares. This protects a shareholder absent through illness from being forced out of the company.
How Does Shareholder Protection Work?
A shareholder dies, is diagnosed as terminally ill or suffers a critical illness condition as defined in the insurer’s terms
A valid claim will then need to be submitted with the insurer as per the policy terms
The insurer pays the sum assured to the other shareholder(s), or directly into the business depending on the policy’s setup
That shareholder or their family can then be bought out, allowing for the monetisation of the shares and ongoing business continuity
Do We Need Business Protection?
If business owners have a sizeable percentage of their personal capital tied up in the company then Shareholder Protection can be an important policy to hold.
What is the risk of passing away?
Based on ONS life expectancy data (2008-10), the chances of someone passing away within the next 10 years are as follows:
30 years old
40 years old
50 years old
1 in 112
1 in 53
1 in 23
Research from insurer Aviva found that 31% of people have had to take time off work due to unexpected ill health, a cancer diagnosis or even a death in the family, so including Critical Illness Cover in a Shareholder Protection policy a very important consideration.
As independent insurance advisers, we pride ourselves on being the experts, knowing every insurance product we offer inside out and back to front. Here’s how we work:
The Fact Find
We will talk you through the options available and capture vital information about the individual or individuals to be covered, as well as the value of your business.
We go out to all leading insurers to gain the most competitive business protection quotes.
We email you a short report with our product and insurer recommendations for the various options we’ve discussed. When you are happy to go ahead in many cases we are able to complete the application with you over the phone.
What is Shareholder Protection?
Shareholder Protection Insurance is designed to pay out a cash lump sum should one of a group of shareholders become critically ill or pass away. It allows the remaining shareholders to buy back the shares of the absent shareholder providing you have the appropriate legal arrangements in place to facilitate this.
The payout ensures business continuity by enabling the remaining shareholders to retain control of the company. Meanwhile, the family of the deceased (or the shareholder themselves, if they’re critically ill) is able to monetise the value of their shareholding.
This capital can be used as they see fit to cope with their new situation.
What happens when there is no Shareholder Protection?
If a director or business partner dies, then without initial planning and consideration the surviving directors could run the risk of the shares passing to someone with no interest in the company or even being sold to a competitor.
A protection policy taken out on the relevant shareholder could ensure the surviving business owners have both the right and the financial means to buy the absent partner’s share of the business from his or her estate (or the shareholder themselves, if they’re critically ill).
In the event of death, business protection ensures difficult questions are avoided and the beneficiaries of the deceased’s estate can realise the value of their share of the business.
Why Shareholder Protection Insurance?
According to research from Legal & General…
- 53% of businesses would cease trading in under a year if a key person died or became critically ill
- Over half of businesses had no formal agreement to establish what would happen in the event of the death or critical illness of a business owner
- 60% of businesses had not reviewed their company agreements in the last year.
If a business partner dies without making specific provisions for their share of the business their interest in the company will likely pass to their estate. The family then has two alternatives:
- A member of the family could take over the deceased’s position as a partner
- The family could realise the value of the business interest by selling it.
Neither of these avenues is problem-free.
Losing control of the business
If a member of the family takes over the deceased’s position as a business shareholder there is no guarantee that they will be able to make any contribution to the business. In fact, in some cases their presence could even be detrimental to the company.
A sleeping partner who is not involved but is entitled to a share of the profits may be a huge burden to the remaining partners. Also the family may be unhappy if it turns out they’re in a position where they have no effective control over the profits of a business which they may be relying on for income.
Selling to an unwelcome party
If the interest is sold the remaining partners may find themselves working with an unwelcome new partner. Or indeed there may be no natural buyers, in which case financial problems may surface not only for the family but also for the business.
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How Does Shareholder Protection Work?
By arranging Share Protection, you are able to ensure the remaining partners have the option and the financial backing to buy back company shares belonging to the deceased should the worst happen. The absent shareholder or their family also gets the option to sell their shares to a willing and able buyer (the company).
Shareholder Protection Life Insurance protects against a policyholder dying or developing a terminal illness by triggering a payout if one of these two scenarios comes to pass. Adding Critical Illness Cover means the policy will also pay out if the individual insured develops one of a set of critical illnesses outlined in the policy documents.
Why Include Shareholder Critical Illness Cover?
Critical Illness Cover pays out should one of a list of critical illnesses or injuries strike. This can include anywhere from 40 to 100+ conditions. Each insurer will define serious illnesses differently, so it’s important to get advice to ensure you get the best policy terms.
Often it’s obvious that there might be severe disruption to a business should a shareholder pass away, but people tend to forget that the same could be true if an individual was rendered out of the business long-term or even indefinitely with a critical illness.
Adding Critical Illness Cover ensures a Shareholders Insurance Policy would cover both disruptive eventualities.
Samantha Haffenden-Angear, Cert CII
Independent Protection Expert at Drewberry
The two most common ways you can set up Shareholder Protection Insurance are:
- Own life under business trust
- Company share purchase
Setting Up Own Life Shareholder Protection Under Business Trust
With this option, each individual to be insured takes out a policy on their own life. This will generally run up to retirement age. These policies are taken out to reflect the value of that individual’s shareholding within the business. Each policy is then written into trust for the benefit if the other shareholder.
Where the premiums are paid by the individual, they are paid out of post-tax income and no tax relief is available on premiums.
Where the company pays for the individual Shareholder Protection premiums on behalf of the shareholders, it’s usually treated as a deductible business expense for corporation tax purposes but the premiums will be considered a P11D or benefit in kind for the shareholders and taxed accordingly.
For both options, the individual remains the owner of the policy, hence the need to write the policy into trust to keep the payout separate from the individual’s estate.
If the insured individual dies, or becomes terminally or critically ill, the benefit is paid to the trustees (i.e. the other shareholders), keeping the cash completely separate from their estate.
The remaining shareholders can then use the payout to buy the outgoing owner’s shares in the business, either from the personal representative of the deceased’s estate or from the shareholder themselves if the payout has been triggered by critical illness.
Why Premium Equalisation is important…
Where the individuals pay for the premiums themselves, to avoid potential tax implications its usually important to equalise the premiums between the individuals paying for cover.
With Life Insurance there will naturally be variations in the cost of cover between the individuals based on factors such as their age and state of health. Equalisation prevents HMRC viewing vastly unequal premiums as conveying a gift between the participants, given that younger shareholder(s) are far more likely to benefit from the higher premiums for a policy paid for by the older shareholders.
Without equalisation the commerciality of the agreement to could come into question and potentially result in unnecessary inheritance tax issues.
Setting Up Company Share Purchase Shareholder Protection
In this example, the company purchases a life insurance policy for each individual shareholder and will usually be set-up to provide cover up to their expected retirement date. No trust is necessary as the money will be paid into the business, where it is typically treated as capital rather than as a revenue receipt for corporation tax purposes.
Should a shareholder die or become critically ill, the payout from the policy goes into the company, providing the necessary funds to buy the shares of the outgoing shareholder. These shares are then bought out and cancelled, effectively increasing the proportionate shareholding of the remaining shareholders.
While this is a similar approach to own life under business trust, there are a few points that must be considered before writing your Shareholder Protection Cover in this way:
- There must be the capability for the company to purchase its own shares under its articles of association. Some older companies, particularly those incorporated before 1982, may not have this right and changing the articles of association to include this right could increase the value of the company’s shares
- Before a company can purchase its own shares, the directors must give a statutory declaration of solvency that will be valid after the outgoing shareholder exits, backed by a favourable report from the company’s auditor
- There are stipulations to be met under the Companies Act to allow a company to legally purchase its own shares
- Rewriting your articles of association to include the right for the company to purchase the deceased’s shares may have the effect of increasing the value of those shares, so it’s vital you account for this in terms of the sum assured
- However, the death of a shareholder could also negatively impact the value of the business and will likely lead to any loans the outgoing shareholder made on behalf of the business having to be repaid, also reducing the value of the company.
From a legal standpoint, company share purchase is the more complex of the two most common methods of setting up Shareholder Protection and the most likely to benefit from the input of an appropriate legal expert.
Shareholder Protection Cross Option Agreement
The process of setting up appropriate business protection should also involve setting up a cross option agreement with all the directors / partners in the business, giving the remaining directors or partners the option to purchase the shares of the business from the deceased’s estate, or from the shareholder themselves if they’re critically ill.
This agreement in turn provides the family or the shareholder with the option to sell the shares to the business and with a willing buyer. They’ll receive cash instead of shares or an interest in a business, allowing the remaining shareholders to retain control of the company.
It’s essential that the company’s articles of association give both parties the option to buy / sell the shares rather than an obligation. An obligation to sell the shares could result in an inheritance tax bill as this may disqualify the shares from business property relief (BPR).
There are two types of option agreements you would use for Shareholder Protection.
- Double Option Agreement
Also known as a cross option agreement, whereby the outgoing and remaining shareholders both have the option to buy / sell but where one party wishes the sale to go ahead the other must comply.
- Single Option Agreement
This is used when Critical Illness Cover is included in the policy. It still gives the insured (i.e. critically ill) shareholder the option to sell their shares but doesn’t give the remaining shareholders the automatic right to buy the shares. This protects the critically ill shareholder from being forced out of the business during their absence.
Our advisers have the skills, knowledge and expertise to set up an effective business protection insurance policy.
However, there are some finer nuances – particularly regarding your company’s shareholder agreement, articles of association and corporate tax law – that we would advise you discussing with your solicitor to ensure thorough due diligence.
Business Protection Expert at Drewberry
Valuing a Company for Shareholder Protection
Valuing a company for any reason, including Shareholder Protection, can be tricky and will very much depend on a variety of different factors. There’s no tried and tested method of valuing a business, as each business is different even within the same industry.
However, some of the common factors an adviser will look at when helping you value your business for Shareholder Protection Insurance include:
- Analysis of the company’s cashflow
- Analysis of the company’s profits, i.e. whether they’re static or increasing
- For companies with a solid, longstanding financial history, multiples of net profit plus cash in bank and assets can be a good method of valuing the business, but this is tricky for startups and newer companies
- Different industries will often command different values, even if underlying business metrics are similar
- Intangible factors will also play a part, such as the company’s reputation and relationship with clients.
As advisers, we’re experienced in helping you value your company for business protection purposes. It will be very much based on factors unique to your particular company, so it pays to get advice when it comes to how much Shareholder Protection you need.
Sam Barr-Worsfold, DipFA
Business Protection Expert at Drewberry
How is Shareholder Protection Insurance Taxed?
The taxation of Shareholder Protection Insurance depends on a variety of factors. Premiums and the payout may be subject to a range of taxes depending on the individual circumstances of you and your company, so it’s always best to seek specialist advice.
Where the individual pays the premiums themselves the premiums are paid from post-tax income and no tax relief is available. The benefit is written into trust for the benefit of the other shareholders, and in the most part protecting the payout from inheritance tax.
As always when it comes to trusts and tax law, it’s best to consult with your solicitor and accountant before putting anything in place that may open you up to a tax liability later on.
Taxation of a own life policy under a business trust…
Where the company pays the premiums on behalf of the shareholder on an own life basis which is set-up under business trust, the company is typically able to deduct this payment as a business expense for corporation tax purposes. However, the shareholders would have to pay tax on the premiums, as these would be a P11D or benefit in kind.
Taxation of a company share purchase arrangement…
Where the premiums are paid under a company share purchase arrangement, these premiums are not typically considered a business expense as they wouldn’t meet the ‘wholly and exclusively for the purposes of trade’ rule, given that the policy isn’t designed to meet loss of profits when the outgoing shareholder dies or becomes critically ill.
As the company owns the policy and makes the policy payments, as well as receives the benefits, there aren’t usually tax implications for the shareholders.
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Best Shareholder Protection Insurance Providers 2018
Aegon was founded as Scottish Equitable in 1831. Dutch insurer Aegon N.V. bought a 40% stake in Scottish Equitable in 1994 and became a 100% stakeholder in 1998.
AIG Life is the UK arm of US insurance giant American International Group Inc. The insurer got its foothold in the UK protection market when it acquired Ageas Protect in 2014.
Aviva was formed out of the Norwich Union-CGU PLC merger in 2000, but the company can trace its roots back to the 17th century.
Legal & General
Legal & General was founded in 1836 and has since grown to become an international provider of insurance, pension and investment products.
Liverpool Victoria has traded as LV= since May 2007. It is one of the largest insurers in the UK with more than 5 million customers across the country.
Royal London began as a friendly society in 1861, later changing to a mutual society in 1908. Today, it is now the UK’s largest mutual life, pensions and investment company and Royal London Shareholder Protection Insurance forms part of a suite of business protection products.
Vitality is owned by South African insurer Discovery Holdings. Discovery entered the UK market in 2007 via a joint venture with PruHealth and PruProtect, part of the Prudential Group.
Get Expert Shareholder Protection Insurance Advice
Like all Business Protection, Shareholder Protection is a complicated area that requires specialist advice.
Our advisers have years of experiences helping businesses just like yours protect what really matters, so don’t hesitate to drop us a call on 02074425880 today or pop us an email on email@example.com.
Tom Conner, BSc, MPhil
Director at Drewberry
Why Work With Drewberry™?
- We placed over £1 billion worth of risk with insurers for our clients in 2017
- We were nominated for Protection Intermediary of the Year at the Protection Review Awards in 2016, 2017 and 2018 and the Cover Excellence Awards in 2016 and 2017
- Our ethos is to provide the best possible service demonstrated by the growing number of 5-star rated reviews with 98% of our clients saying they would recommend us
- Tom, Victoria and the rest of our insurance experts are frequently quoted in leading papers such as The Independent and Financial Times with a reputation in the media as an authority in our industry.