Shareholder Protection Insurance For Business Owners

Discover why this overlooked insurance policy is so important if you or a business partner pass away unexpectedly.

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Graham Cox - Founder & Cemap Mortgage Advisor | SelfEmployedMortgageHub.com
Graham Cox
CeMAP Mortgage & CPSP Specialist Finance Advisor

When a company shareholder dies or becomes terminally ill, the impact on both the business and remaining directors can be profound.

It's typical for a Limited company's Articles of Association or an LLP agreement to stipulate what happens to the deceased owner's share of the business. Usually it will state that the shareholding should be left to the shareholder' dependents or beneficiaries.

But this can have serious consequences for the surviving shareholders.

For example, whilst the beneficiaries may have no interest in the company, their control of a significant stake could potentially disrupt or delay the other owner's ability to make business decisions.

And even if the family members are happy to be sleeping partners, seeking their agreement for an eventual business sale or exit could be made more difficult.

In the worst case scenario, a competitor could end up buying the stake from the family members, before mounting a full takeover bid.

And of course, the deceased's family may want to sell their inherited shareholding quickly. But without a readily available buyer, they could struggle to receive a fair price.

That's where shareholder protection insurance comes in.

Read on to find out how it works, what the tax implications are, and how it can benefit surviving business partners and the deceased's family alike.

What is shareholder protection insurance?

A share protection agreement is a legally binding contract drawn up between the owners of a small business about what happens to an owner's stake should he or she pass away

Upon a shareholder's death, the agreement gives remaining shareholders the right to purchase the deceased's stake from his or her beneficiaries.

Shareholder protection cover is an insurance policy that provides the surviving owners with the financial means to buy the shares from the family members at open market or fair value.

How does shareholder protection work?

Shareholder protection insurance works like this:

  • Each shareholder takes out a life insurance policy. Either with or without critical illness cover.
  • Each life insurance policy must be written into trust at the outset for the benefit of the other owners.
  • One shareholder protection agreement is drawn up to cover all the owners. Typically a cross-option agreement. See below.
  • The trustees keep the shareholder agreement and life insurance policies.
  • Upon a shareholder's death, the trustees claim on the deceased's policy
  • The insurance company pays the lump sum to the business
  • The business purchases the shares from the beneficiaries at the agreed price.

How a cross-option agreement works

A cross-option agreement forms the basis of the shareholder protection agreement. It describes how shares will be sold to the remaining shareholders should one of the parties die, become terminally ill or if chosen for the policy, critically ill.

A cross option is a double-option agreement, which means both parties have the right to exercise their option to buy or sell respectively.

The deceased's beneficiaries have the option to sell their inherited shareholding to the remaining limited company shareholders, who are then obliged to buy them.

Similarly, the remaining shareholders have the right to buy the deceased partners shareholding, and the estate beneficiaries are obliged to sell them.

Either way, the agreement is only activated if one of the parties triggers the purchase or sale after a shareholder's death or terminal illness. A critical illness, if added to the policy could also allow a party to trigger it.

What happens if neither party triggers the cross-option shareholder agreement?

In the unlikely event neither party exercises their option, the deceased party's shareholding would remain with the estate beneficiaries.

Single-option agreement

A single option agreement is typically used where critical illness cover is added to the shareholder protection insurance policy.

It then comes into play if one of the shareholder's becomes critically ill and is either unable to continue working in the business, or no longer wants to.

In such circumstances, it allows for the affected shareholder to force the sale of their shares to the remaining shareholders on the agreed terms.

Unlike the double option, this is a one-way agreement which can only be initiated by the seller, not the buyer.

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Is shareholder protection cover worth it?

Whilst shareholder protection may not be top of mind for small business owners, it can prevent a lot of stess and business disruption if a company shareholder dies, receives a terminal illness diagnosis or, if applicable, suffers a critical illness.

What are the key benefits of shareholder protection insurance?

Shareholder protection enables remaining business owners to keep control of their company, so they can continue to operate it in the way they deem best.

The business also protects itself from competitors or unwanted suitors taking control of the business.

Lump sum benefit for the deceased owner's beneficiaries

For the deceased's family or beneficiaries, the lump sum payment protects their financial future and ensures they receive a fair price for their stake in the business.

It also protects them from the sudden loss of income caused by their loved one passing away.

Finally, shareholder protection provides certainty and peace of mind for all the parties involved,

How is a business valued for shareholder protection?

There are a few ways to value a business for the purposes of taking out shareholder protection insurance. The first step is to work out a fair or open market-value for the business as a whole. For instance:

  • Using a multiple of the average of pre-tax net profit over the past three years.
  • A fixed value, which factors in some of the expected business growth
  • Based off the net asset value on the balance sheet. Again a multiple could be used to anticipate some growth in it's value.

Once a company value is agree, each shareholder's level of cover is apportioned according to their stake in the business.

Ultimately of course, the level of cover may come down to how much the individual shareholder's or business can afford, so it's crucial to get agreement in advance.

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How much does shareholder protection cost?

As shareholder protection is life cover, the cost of the monthly premiums will depend on a huge range of factors including but not limited to:

  • age
  • policy duration
  • the level of cover required and whether critical illness cover is added
  • health, including any pre-existing condtions
  • lifestyle
  • family medical history

Because there's so many variables, the cost could range from from £10-20 a month all the way up to three figures a month.

Who pays for shareholder protection insurance?

Either the business or the individual shareholders/directors can pay for shareholder protection insurance.

The most suitable payment route depends on the number of business owners and the tax implications for the company and individuals concerned.

There are three common scenarios. Two where the individuals purchase cover and one paid for by the business:

1. Life of another policy

Commonly used where there are just two business owners. Each shareholder pays for a policy on the life of the other, in conjunction with a cross-option shareholder agreement.

Upon a business partner passing away, the surviving partner claims on the policy and uses the funds to purchase the deceased's shares.

2. Own life cover

Each business owner takes out and pays for share protection on their own life, with the policy written into a business trust.

Upon an owner's death, the trustees claim from the insurer and the proceeds are used by the business to purchase the deceased's stake.

3. Company share purchase

The Ltd company, partnership or LLP owns the policies and pays the premiums.

When a business owner dies, the company makes the claim and uses the lump sum payment to purchase the shares from the deceased's family or beneficiaries.

One caveat. The tax implications of a company share purchase are often quite complicated. It's therefore recommended you take independent tax advice before going down this route.

Is a shareholder protection policy tax deductible?

If the shareholder protection premiums are paid for by the business, then the premiums are a tax-deductible business expense.

However, HMRC regulations stipulate the cost is a P11D benefit-in-kind to the shareholders, so each owner would pay additional income tax and national insurance contributions.

If the individual owners pay the insurance premiums, the costs are neither a tax-deductible business expense nor shareholder benefit-in-kind.

Getting a quote for shareholder protection insurance

Self Employed Mortgage Hub are a mortgage and protection specialist broker, and have access to both major business insurance companies and niche providers. Giving you the best chance of finding the most suitable shareholder protection plan for your business and individual circumstances.

For a fast, no-obligation quote, call 0117 205 0655. There's no call-center, and no wait times. Alternatively, please enter your details here, it only takes a minute.

We're here to help so if you have questions or need advice on any aspect of shareholder protection, please get in touch.