Considering the future of your business in the event of the death of a shareholder is not always top of a business owner’s list and shareholder protection is not something people regularly review. However, if you or any other co-owners in your business pass away, their shares could be inherited by their next of kin – and this poses several potential risks to your company.
If the deceased shareholders beneficiaries receive the shares, they could become involved in business decisions without having the necessary skills or expertise. They could also sell the shares to somebody else who isn’t qualified – or even to a competitor. If the remaining owners wanted to issue dividend payments, these would also be paid to the beneficiary – even if they aren’t involved in the day-to-day running of the business.
This situation all poses risks for the beneficiaries; there is no guarantee that they will receive the full market value of these shares if somebody else offers to buy them.
How shareholder protection can help
Directors may believe that they are protected by their company’s ‘articles of association’ – which often state that, on the death of one or more shareholders, the surviving shareholders must buy their shares. But what if there isn’t enough money available to buy the shares at market value?
This is all too common. I recently spoke with five people from an IT company. Each held a 20% stake in the company, which was valued £2 million – but there was only £250,000 in the business bank account. I asked them how they would find the extra £150,000 to buy the shares if one of them died.
In such a case, it might be possible to apply for a bank loan, but this isn’t always possible. The death of a co-owner or other significant person can disrupt or potentially shut down a business. Banks are aware of these risks and may not be willing to loan the money if they are concerned about being repaid.
The options for shareholder protection
There are three ways to set up shareholder protection. The first is to use a ‘life of another’ policy. This is typically used when there are only two shareholders. Both take out a life insurance policy and name the other as the beneficiary – so if they die, the remaining shareholder will receive the proceeds and can use the money to purchase the deceased’s shares from their next of kin.
What if there are more than two shareholders? A better option may be to set up own life policies held under a business trust; each shareholder takes out insurance on their own life and the company pays the premiums. The death benefits are written into a business trust with the other shareholders named as trustees. Upon a shareholder’s death, the lump sum will be paid to the trustees and can be used to purchase the deceased’s shares.
Alternatively, a company share purchase agreements requires the company to take out life insurance policies on all of the directors, who receive the proceeds upon one of their deaths. The company then buys the shares from the beneficiaries and cancels them. Businesses should be more than five years old before considering a share purchase agreement. Otherwise the share purchase could be liable to Capital Tax Gains.
The value of your business – and your shares – will change over time, so it’s important to review the your level of shareholder protection regularly. This can help to ensure that there will not be a shortfall when it comes to purchasing the deceased’s shares, and also that you are not paying premiums for a level of cover that you don’t actually need.
At Haines Watts we know how important it is to protect your business from unforeseen risks. We have a close relationship with the regulated financial advisors at Tilney, who spend their days helping business owners in this area. Find out more about wealth planning & protection.
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If you want to know more about shareholder protection and want to make sure that your business is protected against risks, you could speak to a financial planner. They can talk you through the options and recommend the most suitable course of action to protect you and your business. Get in touch with your local Haines Watts advisor for more information.