If you’re a shareholder in a business it’s crucial to consider what would happen to both yourself and the company if you died or left the business through a serious illness.
It’s more than just coping without a shareholding director’s vision, drive and talent. While not always easy, you could recruit a replacement for the departed shareholder.
What’s more difficult is figuring out what to do with the shares of a director who dies or exits the business through critical illness. It’s here the consequences of getting it wrong, or even simply inaction, are more serious for all involved.
Unfortunately, few shareholders or companies are prepared. Research from Legal & General found half of businesses have no agreement on what would happen to a business owner’s shares if that owner died or became critically ill.
What happens to the shares in my business when I die?
Without anything stating otherwise, a business partner’s shares become part of their estate on death. They’re distributed as per their will (or the rules of intestacy if they died without a will). The deceased shareholder’s family therefore typically inherits the shares.
At this point, the family has two main options: Take over the deceased’s position in the company or sell the shares to realise their value.
Yet in many cases, neither option works for both the company and the family. If a family member takes over, the surviving business partners could gain a sleeping partner without the aptitude to help run the company but still drawing a share of the profits.
Meanwhile, the family could be unhappy if they feel they have no say in a company they rely on for income.
If the family sells, the company may not financially be able to buy back the deceased shareholder’s shares. The family could then sell to a third party, resulting in the surviving shareholders losing control of the company.
There may even be no natural buyers for the shares, leading to financial problems for the company and the family.
What happens to the shares in my company if I’m ill?
If you’re forced to leave your company due to serious ill health, you remain a shareholder. However, being ill you’re unlikely to be able to contribute to the company’s success as you once did. Your fellow shareholders again effectively end up with a sleeping partner.
Alternatively, you may need to monetise your shares to meet the costs of ill health, for example adapting your home due to a new disability or funding early retirement if you’re unable to work again.
Once more, if the company cannot afford to buy you out, you could end up having to sell to a third party, perhaps even a competitor, to raise the funds you need. After working so hard to build your business, this could come as a real blow.
How shareholder protection insurance helps
Recognising the significant issues around losing a shareholder, the industry introduced Shareholder Protection. It’s an insurance policy which pays out to the company so it can buy back an absent shareholder’s shares should a shareholder die or become critically ill.
The company and remaining shareholders therefore retain control of the absent shareholder’s shares, allowing for smooth succession planning and letting the business continue trading as normal.
Furthermore, the company can pay either the absent shareholder (if that shareholder is critically ill) or the shareholder’s family (if the shareholder has died) in full for the shares. The departing shareholder or their family gets a ready buyer without having to sell to a competitor.
Shareholder protection: what you need to know
Companies across the country use Shareholder Protection to protect their business, shareholders and shareholders’ families. However, it’s among the most complicated insurance policies to arrange.
How to buy it
For starters, there are three distinct ways to buy Shareholder Protection:
- On a life of another basis
- On a company share purchase basis
- Own life under business trust.
Which one is best for your company depends on your circumstances.
To further complicate matters, HMRC considers Shareholder Protection differently for tax purposes depending on how you purchase it. If the business pays premiums, in some cases it’s a deductible expense against corporation tax. Yet in other instances where the business pays, this isn’t the case.
Articles of association and cross option agreements
Moreover, you’ll need to consider what your articles of association permit when buying back an absent shareholder’s shares. Otherwise, you could find that despite having the funds the company can’t legally facilitate the buy back.
Yet another issue is that you may need a cross option agreement laying out the terms of any future share purchase should the policy come into play. If incorrectly drafted, it could impact business property relief available on a deceased shareholder’s shares for inheritance tax purposes.
Lastly, you may have to equalise premiums between shareholders depending on how you buy a policy. This ensures the difference in premiums between those paying the most (for example, an older, majority shareholder) and those paying the least (for instance, a younger, minority shareholder) isn’t considered a transfer of wealth for inheritance tax purposes.
Getting expert advice
With so much to consider, expert advice is essential. An adviser can:
- Assist with valuing your company
- Discuss how to pay for a policy
- Talk through the tax implications
- Cover the merits of a Life-only vs a Life and Critical Illness policy
- Set up a business trust where required.
That’s why we’ve teamed up with independent advisers Drewberry to help Company Bug readers with Shareholder Protection. Not only do they search the whole market to find the best policy for the best premiums, their experience in arranging Shareholder Protection means they cover all the right bases on your behalf.
With around 2,700 5-star reviews to their name, Drewberry is dedicated to providing the best customer service and getting your company and your shareholders the protection they deserve.
More on transferring shares.