Have you got the right shareholder protection?

Taking out shareholder protection insurance can protect a business from financial pressures in the event a shareholder dies or becomes too ill to carry on in the business.

Without shareholder protection insurance, there’s no guarantee the business will have the finances available to buy back the outgoing shares from a deceased shareholder’s estate or beneficiaries.

shareholder

This becomes more complicated if there’s a cross option agreement in place between the remaining shareholder and the beneficiaries.

If the beneficiaries trigger the agreement, it means the remaining shareholders have to buy those shares.

And if they’re taking capital out of the business, it could seriously put the financial future of the business at risk.

The alternative is they try to fund the purchase with their personal savings.

Shareholder protection removes these financial stresses by providing a lump sum payout on an insurance plan in the event of a shareholder’s death.

Shareholder protection insurance is actually an umbrella term for a range of products and there are a number of policy types you could choose.

Here we’ll give you an overview of the different types of shareholder protection insurance you could get, and which you could be best suited for based on your business type and size.

What types of shareholder protection insurance are there?

Life of another insurance policy

Under a life of another policy, each of the shareholders take out their own policy and pay the premiums individually.

In this scenario, each shareholder would find their own insurance provider, and would be responsible for the information and payments related to their own policy.

They’d each write into the policy that, in the event of their death, the payout on the premiums would go to the remaining shareholders.

Those funds would then be used to purchase the deceased’s shares.

Which businesses are best suited to a life of another policy?

Typically speaking a life on another policy is best suited to a business with just two shareholders.

While it’s possible to get a life of another policy with more than two shareholders, the disbursement of money can get complicated with a larger number of shareholders, which can cause delays and disruption to the business.

Life of another policy and tax

Plus, because the life of another policies are owned by the individual shareholders and paid out of taxed income, they can’t be used for tax breaks.

Shareholder protection insurance in a business trust

Shareholder protection insurance in business trust works much the same as life of another – but can be more beneficial to businesses with more than two shareholders.

This is because of the way the trust deals with the disbursement of funds in the event of a death.

With shareholder protection in a business trust, each shareholder buys and takes responsibility for their own policy (much like a life of another policy).

The difference is, each policy is then written into a single business trust, with the remaining shareholder identified as the recipients of any payouts.

In the event of shareholder death, the trust will then distribute the payout equally to each remaining shareholders.

This is with the understanding they’ll use the funds to purchase the deceased shareholder’s shares from their estate or beneficiaries.

Which businesses are suited to shareholder protection in a trust

Putting shareholder protection in a business trust would be highly recommended to any business with more than two shareholders.

This is because the role of the trust is to distribute any payout equally between each remaining shareholder.

Tax and shareholder protection in a trust

Although the policies are written into a trust, because each shareholder is paying the premiums on their individual policy through taxed income, writing shareholder protection into a business trust doesn’t qualify it for any tax relief.

Company owned shareholder protection insurance

The final option is for the company itself to take out plans on each of the shareholders.

In this scenario the company is the owner of the policies and will pay for the premiums.

The shareholder will be the named beneficiaries and the people covered under the plan.

As the owner of the policy, the company will receive any payouts from the policy and use the funds to buy back any outgoing shares.

Each shareholder will be covered individually by a life of another plan.

It’s also advisable to have a cross option agreement written between the company and the shareholders or their beneficiaries, setting out that the funds will be used to buy back the shares in the event of a death.

There are several criteria that also need to be met under The Companies Act 2006 before the buy back can go ahead.

For example, the articles of association can’t prevent the sale of the shares back to the company, and the funds must be used to buy back the shares before any additional capital is used.

But, having shareholder protection and a cross option agreement in place will smooth the process considerably.

Which type of company is suited to a company owned shareholder protection policy?

Typically any company – regardless of the number of shareholders – could be suited to a company owned policy.

This is because the policy itself is owned by the business and the payout also goes to the business.

This removed any complications distributing funds between multiple parties.

Is a company owned shareholder protection policy tax effective

Compared to shareholders taking out and paying for their own policies from taxable income, yes, a company owned shareholder protection policy can be more tax effective.

The policy won’t be liable for corporation tax relief on the premiums, but because the policies are company owned, they’re not considered a benefit in kind, so the individual shareholders won’t pay on their policy, despite being covered.

And because any payout is used for capital investment (buying back shares) rather than for day-to-day trading, it won’t be liable for any corporation tax.

What do you need to set up a Shareholder Protection Policy?

Whatever type of shareholder protection policy you decide to invest in, the process of getting the policy will be the same.

You’ll also need to submit the same kind of information as part of the application process.

Like any other life insurance policy, the information you’ll need will include:

  • The age of the applicant
  • Details of their current lifestyle (like if they smoke, how much they drink etc)
  • Details of any pre-existing health conditions
  • The level of cover you need (this will be based on the cost of paying for the shares)

How each shareholder answers these questions will determine how much they’ll pay in premiums.

It’s very important to understand that if any information on the policy is incorrect it could affect the payout, so make sure every detail is accurate.

If anything changes in the life of a shareholder, make sure the policy is updated appropriately.

Reviewing your shareholder protection insurance

It’s always advisable to take out shareholder protection from the beginning of the business.

For a start, it will be cheaper.

Because the insurance has been taken out when the shareholders are younger (and theoretically less likely to have pre-existing health conditions) the premiums will be lower.

It also means by the time the shareholders reach an age when some health conditions become more common, they’ll built up the policy and will have saved a significant amount of money.

If you only take out the shareholder protection insurance later, it will cost more because of the personal factors.

But the other thing to consider when it comes to the lifetime of the shareholder protection insurance, is how the value of the shares will increase over time.

While the level of cover you have at the beginning might be enough to cover the business in the early years, if those shares become more valuable over time, you may not have enough cover when it comes time to make a claim.

So it’s important to periodically review your shareholder protection in line with any business changes to ensure you have the right level of shareholder protection.

Preparing for the worst with the right shareholder protection

Shareholder protection insurance, like any life insurance, is an investment in the future you hope you never need to use.

But it’s critical to consider the future of the business and the employees you’re responsible for.

Even in the worst case scenario, you need to ensure they are taken care of and their own future is protected.

By investigating and investing in the right type and level of shareholder protection, you can keep the business protected and its financial future assured in the event the worst should happen.