What happens to your company if a major shareholder dies? The answer is, you can’t be sure – and that’s not good. Robert Harvey, Head of Protection Advice at Drewberry, shows you how to restore certainty.
Picture your predicament. A senior colleague and shareholder in your company has sadly died, and naturally her nearest and dearest inherit her estate – which includes her shares. Suddenly, your company is part-owned by someone (or several someones) who may have no knowledge of your business – yet they now have a say in how it’s run. On the other hand, they may have no interest at all in running the company with you. Either way, it’s not a sustainable situation.
The obvious solution is for the people who have inherited the shares to sell them back to you. But this means you have to find the money to do so – and your company simply may not have that much spare cash lying around.
This is why companies with a few major shareholders are often advised to take out shareholder protection insurance.
What is shareholder protection insurance for?
Shareholder protection insurance helps ensure a smooth transition of a shareholding should a shareholder die (or become critically ill, if you’ve added critical illness cover to the policy). It provides ready cash for the remaining shareholder(s) to buy an absent shareholder’s shares, and also means there’ll be a willing buyer for those shares, if the new owner (or the incapacitated shareholder) wishes to sell.
In the event of a shareholder’s death, the shares form part of their estate and so usually pass to their family. If the company does not buy those shares back, the family could end up becoming a drain on the business, since they’d have rights to a slice of the profits without necessarily helping to run the company. They may even look to monetise their stake in the business by selling to a competitor, or hinder the business in other ways by making poor decisions.
How does shareholder protection insurance work?
Shareholder protection is arguably the most sophisticated of business protection products. There are a large a number of different factors that must be taken into account before you can get suitably protected. These range from the basics – e.g. how are you planning to purchase your cover (which affects the tax position), to the shareholder and cross option agreements. These are the agreements that underpin what will happen to the shares in the event that a payout is triggered.
Case study in shareholder protection: Interface NRM
One of Drewberry’s recent clients in this area is Interface NRM. Founded in 2002, this UKAS-accredited certification firm provides environmental credentials to third parties. Founding partner Dr Gavin Jordan recalls, ‘By 2018 the business had grown to be worth quite a bit. By that point we were both in our early 50s and so had started to think we could do with getting some kind of insurance in place in case something went horribly wrong. Essentially, we wanted to make sure the business and staff would be okay should anything happen to us. We also wanted to ensure our families would be taken care of as well.’
It was these concerns that led Gavin and his business partner Michael to Drewberry, where they were advised by Victoria Slade. ‘I recommended shareholder protection to Gavin and Michael with both life insurance and serious illness insurance,’ Victoria explains. ‘This would protect them both in the eventuality that they passed away as well as if they became seriously ill – which is important, given that a serious illness can have exactly the same impact on a business as the death of a shareholder.’
Victoria also set up the appropriate trust to hold the benefit should it be paid out, allowing the business to have prompt access to the funds as soon as they might be needed. A trust also reduces any tax concerns about the benefit being paid back into the business, as a trust is an entity entirely separate from the company. The result has been peace of mind for both of Interface NRM’s owners.
‘From start to finish, the entire process was so simple thanks to Victoria’s hard work,’ says Gavin. ‘Now we have the cover we need, we can continue growing the business safe in the knowledge that, should the worst happen, we’ve got the cover necessary to make it through.’