Your business may be providing for you and your family today, but how do you ensure that it will continue to do so, even when you might no longer be around to run it?
If you were to pass away, what happens to your shares in your business, as well as the business itself and your business partners? And, more importantly, how would your family cope financially if the income from the company makes up the majority of household earnings?
Imagine there’s a company with two shareholders, David and John, who each own 50% of the business.
Does your business have the ready capital at hand to pay out half its value to the widow(er) or other beneficiary of a deceased shareholder so the surviving shareholder(s) can retain control of the business?
To return to the above example, if John and the company can’t raise the capital necessary to buy back David’s share of the business from Clare one of two things could happen. Clare may firstly look to continue drawing profit from the business, as is her right as a shareholder, even though she isn’t contributing to the company. Alternatively, she may decide to monetise the shares by selling to a competitor so she has the ready funds she needs to maintain her and her children’s lifestyle.
Neither option is particularly palatable for John or the business, which is why many of our clients look to get Shareholder Protection in place.
This is an insurance policy designed to pay out on the death of a shareholder, giving the company the necessary capital to buy back the deceased shareholder’s shares.
In the above example, imagine that, 2 years prior to David’s death, David and John entered into a Shareholder Protection Insurance contract that agreed, should one shareholder die, to pay the surviving shareholder the monetary value of a deceased shareholder’s share of the business.
In this case, John would receive the proceeds from the Shareholder Protection Insurance and use these funds to buy David’s share of the business from Clare. This gives John full control over the company and Clare the cash she needs to fund her lifestyle on an ongoing basis.
For this to work effectively, David and John must have ensured that there was a cross option agreement in place at the outset of the policy.
A cross option agreement is an important piece of business administration when you set up Shareholder Protection. It provides the surviving shareholder(s) with the option to buy the shares of the deceased business owner.
In addition to the surviving shareholders being able to call their option to buy the shares, the legal representatives of the deceased’s estate also have the option to sell the shares of the deceased business owner to the remaining shareholders.
In either case, whether the remaining business owners want to buy the shares or the legal representatives want to sell, the agreement ensures the option is exercised.
The cross option agreement must be set up in this manner to ensure there is no binding clause for sale, i.e. in certain circumstances neither party could exercise their option. This typically means Business Property Relief on the shares is retained for inheritance tax purposes.
Your articles of association effectively act like a crude business will, dictating what happens to the shares of a deceased or critically ill shareholder.
Usually, the personal representatives of the deceased and subsequently their beneficiaries will become entitled to the deceased’s share of the business, as in the above example where Clare inherited her husband’s share in the company.
The articles of association will dictate what rights the existing shareholders have over the shares of a deceased, but must be structured carefully to avoid the above situation where there’s a binding clause for sale. The articles of association cannot say that the beneficiaries of a deceased shareholder must sell the shares and the company must buy them back, because this would violate the entitlement of any beneficiaries to Business Property Relief for inheritance tax purposes.
If in doubt, seek advice from an expert, such as a financial adviser or your solicitor.
Essentially, if you want your loved ones to benefit from your shares in a business after you’re gone but aren’t sure whether the company would have sufficient funds to buy back your share should you pass away, Shareholder Protection Insurance is something you’ll want to consider.
For help and advice, don’t hesitate to drop us a call on 02084327333.
Director at Drewberry
Our goal is simple: to improve our clients’ financial wellbeing.
We help our clients take control of their finances by building lasting relationships where we support them to make informed decisions.
We provide financial advice services to individuals and businesses throughout the UK. Whether it’s setting up personal insurance to protect your lifestyle, managing your pensions, investments and other assets to improve your financial future or setting up employee benefits for a company, we’re here to help.
I’ve held a policy with Drewberry for several years now. They are always friendly, insightful and offer great service.