SHAREHOLDER
PROTECTION
Designed to protect a business from the potentially damaging financial implications of a shareholder's or partner's death, this product typically consists of life insurance to which critical illness cover may be added.
SHAREHOLDER PROTECTION UK
WHY SHAREHOLDER PROTECTION MATTERS
Dealing with ownership in a company can be difficult in the event of an untimely death or illness of a controlling shareholder. Directors loans must be repaid. The value of the shares needs to be considered as they have left the business. Control and management of the business may be compromised along with finance and banking facilities.
A shareholder or partnership agreement can set out how the shares should be valued and can give the surviving shareholders the right of first refusal to purchase shares. Quite often, these agreements are not in place, creating uncertainty in a situation which can lead to dispute.. That said, even when an agreement is in place, is the necessary capital?
SAFEGUARDING A BUSINESS WHEN A SHAREHOLDER DIES
Ownership protection, known as either shareholder or partnership protection, is an arrangement of insurance and option agreements which protects the surviving business owners on the death or serious illness of a fellow owner. This protection provides both the necessary capital and rights to the shares ensuring surviving business owners can keep control of the business while providing the value of the shares to the family of any deceased owner.
An additional benefit to a well structured insurance arrangement reduces the complexity, restrictions and legal considerations required when funding share purchase from corporate funds.
SETTING UP SHAREHOLDER PROTECTION
In summary, the issue will be control and money.
If a shareholder dies, their shares will typically fall into their estate and will usually end up with the surviving family. Ultimately, this means someone outside your business now owns a share of it. Do you want to work with someone who may have little or no experience? Will they agree with your vision and corporate aspirations? How much profit do you pay away going forward? Does a dispute over money make litigation look likely ? Who has control?
If you have one, a shareholder agreement will set out what should happen but it won't provide the money required to buy the shares. If the company's own capital can provide the funds to buy the shares back there will be a lengthy process to adhere to, which may not necessarily allow the transfer to happen. Are you prepared to introduce additional capital of your own or can you borrow the money? These issues can all be avoided with some effective estate planning and a robust shareholder protection arrangement.
So how is it set up?
There are three main ways to set up a shareholder protection arrangement;
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Life of Another
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Own Life in Trust
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Company Share Purchase
Each method has its own merits and we can advise on the best course of action depending on the structure of your business and its financial background. The tax treatment of both premiums and proceeds will differ depending on the type of arrangement chosen.
Again, depending on the arrangement, it will be necessary to enter into an explicit agreement which stipulates what happens on the death of any controlling shareholder regarding the options available to all parties relating to the transfer or sale and purchase of shares.
It can also be agreed that if any controlling shareholder suffers a critical illness, the affected shareholder can choose to sell their shares and leave the business or keep their shares and remain in the business. If they decide to sell, the remaining shareholders must buy the shares.
These explicit agreements are called double and single option agreements. We will advise and provide draft copy agreements for your legal advisers.
Any policies you set up must be aligned with the company's Articles of Association and any shareholders’ agreement.
Depending on the arrangement advised, there may also need to be a trust and/or buyback document in place, for them to be effective.
At Optima Health and Life, our consultants are here to guide you through the entire process, ensuring absolute peace of mind. Committed to delivering exceptional service and advice, we cater to both businesses and individuals alike.
IT'S IMPORTANT TO UNDERSTAND THE MONETARY VALUE
OF YOUR BUSINESS.
Similar to any other life insurance policy, we will assist you and recommend the necessary cover. Consulting with your accountants and/or fellow shareholders should simplify the process of accurately evaluating your business and, consequently, the cover required to acquire the equity stake of all insured shareholders.
FREQUENTLY ASKED QUESTIONS
IS MY BUSINESS AT RISK?
If a shareholder in your private limited company, member of your Limited Liability Partnership (LLP) or partner in your Partnership were to die, could you afford to purchase their share of the business? Do you have access to the capital required to do this today? Can you repay any directors loans immediately?
If not, there could be significant implications for the future and survival of your business. Shareholder protection or Partnership protection can help you protect the ownership of your business in this situation.
WHAT IS SHARE PROTECTION?
Shareholder protection, is an arrangement of insurance and option agreements which protects the surviving business owners on the death or serious illness of a fellow owner. This protection arrangement provides both the necessary capital and rights to the shares ensuring surviving business owners can keep control of the business whilst providing the cash value of the shares to the family of any deceased owner.
HOW DOES SHARE PROTECTION WORK?
In the event of a business owner dying or being diagnosed with a terminal illness (life expectancy less than 12 months) or a specified critical illness, share protection arrangements can provide a lump sum to the remaining business owners.
This means that if a valid claim is made during the term of the policy, the lump sum could be used to help purchase the deceased partner, shareholding director, or member’s interest in the business.
WHAT IS A CROSS OPTION AGREEMENT?
Also known as a double option agreement, it consists of an option agreement between the business owners usually backed up by an insurance policy owned by the company or held within a specific type of trust. The agreement grants the business owners options on their shares and the options don't come into force until a shareholder dies. The agreement stipulates that surviving business owners have the option requiring the deceased’s executors or personal representative to sell the shares to them. The deceased's executors or personal representatives have the corresponding option to require the surviving business owners to buy within a specified period (for example, two months from the date of death). If either party exercises their option, the other party must comply.
The surviving business owners will buy the deceased business owners share in the proportion to which they are already entitled to the balance of the business.
While double option agreements are generally used for life cover, they are less appropriate for terminal illness or critical illness, where a single option may be more appropriate.
Because the parties only have the option to buy, the agreement is not a binding contract for sale and so it should still be possible for representatives of the deceased to claim business property relief for IHT calculations.
The agreement will require that each business owner must take out and maintain a life policy to provide a lump sum to buy their share. The policy will be written under a special share protection trust with the other business owners also being trustees.
This offers peace of mind to the family left behind, as they know they will have a willing buyer of shares they may no longer want, and remaining shareholders can relax in the knowledge that they will have the option to purchase.
If a business owner dies with no share protection in place, their share in the business may be passed onto their family. This means that the surviving business owners could lose control of a proportion of the business, or in some circumstances, all of it. The family may choose to become involved in the ongoing running of the business or could even sell their share to a competitor.
HOW CAN A COMPANY USE ITS OWN CAPITAL TO BUY SHARES BACK FROM A DECEASED SHAREHOLDER?
To use its own capital to buy shares back from a deceased shareholder, a UK company typically follows these steps:
Valuation: Determine the fair market value of the deceased shareholder's shares. This can be done through a professional valuation or based on a predetermined formula, as specified in the company's shareholder agreement.
Board Approval: Obtain approval from the board of directors to proceed with the share buyback using the company's capital. Present a proposal outlining the reasons for the buyback and the potential impact on the company's financials.
Shareholder Agreement Compliance: Ensure compliance with any provisions related to share buybacks outlined in the company's shareholder agreement. Some agreements may have specific conditions or procedures for share transactions in the event of a shareholder's death.
Offer to Estate: Extend a formal offer to the estate of the deceased shareholder to repurchase the shares at the agreed-upon valuation. Clearly outline the terms, including payment structure and any applicable conditions.
Legal Documentation: Draft legal documents, such as a share purchase agreement, to formalize the buyback. This document should detail the terms and conditions of the transaction and the responsibilities of both parties.
Funding Mechanism: Use the company's capital or reserves to fund the share buyback. Ensure that the company has sufficient liquidity and adheres to any legal or regulatory requirements regarding the use of its capital for such purposes.
Creditor Approval: If the company has outstanding debt, existing creditors may have rights that need to be considered. In some cases, particularly if the share buyback impacts the company's ability to meet its debt obligations, creditor approval or consultation may be necessary.
Companies Act 2006: The Companies Act 2006 sets out rules and restrictions regarding share buybacks by companies. The company must comply with the provisions of the Act, including financial assistance rules and limits on the amount of capital that can be used for buybacks.
Directors' Fiduciary Duties: Directors have fiduciary duties to act in the best interests of the company. They must consider the potential impact of a share buyback on the company's financial stability, existing creditors, and the overall interests of shareholders.
Share Transfer: Once the agreement is finalised, facilitate the transfer of shares from the deceased shareholder's estate to the company. Update the company's shareholder records accordingly.
Compliance and Filings: Ensure compliance with legal and regulatory requirements related to share buybacks and transfers. This may involve filing necessary documents with regulatory authorities and updating the company's records in accordance with the law.
Professional Guidance: Seek guidance from legal and financial professionals throughout the process to ensure compliance and the proper execution of the share buyback.
Communication: Maintain open and transparent communication with the deceased shareholder's estate, keeping them informed throughout the process and obtaining any necessary consents.
It's crucial to involve legal and financial professionals to navigate the legal intricacies and ensure that the share buyback is conducted in accordance with applicable laws and regulations. Additionally, maintaining sensitivity and clear communication with the deceased shareholder's estate is essential for a smooth transaction.
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.
Staying in control of the business by preventing the shares being inherited by an unwanted beneficiary, whose priorities may not align with yours.
Reducing disruption at a challenging time for your business by making an eventual transfer of shares as orderly as possible.
Having 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.
Avoiding costly buy-out capital meaning you won’t have to dip into your savings or equity.
You can also 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
Due to the qualifying nature or absence of surrender value in each policy, there will be no income tax liability on the proceeds in the event of a death claim. Additionally, Capital Gains Tax is not applicable as the proceeds are payable to the original beneficial owners, i.e., the surviving business owners.
However, in the case of a valid critical illness or terminal illness claim, selling shares may incur capital gains liability. This liability is calculated based on the difference between the purchase and selling prices of the shares. If the selling price exceeds the purchase price, resulting in a capital gain, Capital Gains Tax may be applicable.
Strategies to mitigate the impact of capital gains taxation will be discussed if this benefit is part of the arrangement.
When all business owners participate in share protection, there will be no Inheritance Tax (IHT) at the outset or when additional premiums are paid. This is attributed to the arrangement being deemed a bona fide business transaction for full consideration with no gratuitous intent (as per the Inheritance Act 1984, IHT 1984 S 10), considering the involvement of all business owners.
No surrender Inheritance Tax is levied on the policy upon death, as there is no transfer of value. Similarly, Inheritance Tax on share protection upon death is exempt due to the application of 100% business property relief.
SHARE
PROTECTION
6 OUT OF 10
BUSINESS OWNERS
Said they had no protection in place to cover the cost of purchasing shares should a business owner die
L&G 2018 Business Research