Shareholder Protection Insurance

In this, our guide to shareholder protection insurance, we explain everything you need to know about this type of business life insurance, what it is and why it might give you some peace of mind.

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Legal and General LogoLV LogoRoyal London Logo
Scottish Widows LogoVitality LogoZurich Logo
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Royal London LogoScottish Widows LogoVitality LogoZurich Logo

Introduction to shareholder protection insurance

The loss of a shareholder is a serious event for any company, with many businesses relying on their owners for both equity and leadership. Upon their death, and without a proper plan in place, the shareholder's equity would pass to their estate, which means their family members would likely become owners of the company. While on the face of it this may not seem like an issue, those family members may have no interest in the business and could even decide to sell the shares on to an unknown third party.

The good news is that businesses can protect themselves from some of the impacts of losing a shareholder by taking out shareholder protection insurance, which ensures a succession plan is in place and is funded too.

What is shareholder protection insurance?

The loss of a shareholder can be a traumatic time for a business, with lots of uncertainty and often disputes over how the company should carry on. Without succession planning, preparation and policies in place, a deceased business owner's shares would pass to their estate, leaving it up to their family to decide what should be done with the shareholding. This could mean a family member with little business experience could try to change the direction of the company or perhaps sell the stake on to someone else, at worst a rival.

What is shareholder protection insurance

Existing shareholders may well want to buy the shares, but with delays due to probate or difficulty raising funds, they could miss out. Setting up a shareholder agreement which details what will happen if an owner passes away is a good first step, but it still doesn't solve the issue of raising the funds required to buy the shares. That's where shareholder protection insurance comes in; a type of life insurance, it provides a cash lump sum to the business, allowing it to buy back the shares at a pre-agreed price. That's not all though, shareholder protection policies will usually also cover terminal illnesses and you'll have the option to add critical illness protection too, so you can protect the business from not only the death of a shareholder but also their absence due to serious illness.

How does shareholder protection insurance work?

Should I add critical illness cover?

All shareholder protection insurance policies cover both the death of the insured and the diagnosis of a terminal illness with less than 12 months to live. But that still means you're somewhat exposed should the shareholder become critically ill and be unable to work for the foreseeable future. That's where critical illness policies come in.

What does critical illness cover?

Critical illness cover will pay a cash lump sum to the business in the event of the insured shareholder becoming seriously unwell and suffering from conditions such as a heart attack or cancer (exactly what is defined as a critical illness will vary between providers). Those funds can then be used to buy out the partner, or at least lessen the impact of their absence, while at the same time potentially providing the person who is critically ill with some much-needed capital.

How does shareholder protection insurance work?

Shareholder protection pays out a cash lump sum to either a single named beneficiary or a group of beneficiaries in the event the insured shareholder dies, or is diagnosed with a terminal illness and given less than 12 months to live. This payout is designed to provide the remaining shareholders with the required funds to purchase the shares from the deceased's estate. By opting for critical illness cover the policy will also pay out if the insured suffers from a serious illness that's covered by the policy which, as a result, forces them to leave work.

It's important to point out that shareholder protection cover needs to be set up alongside a modification of the company's articles of association. Option agreements should always be drawn up with the help of either an independent financial adviser or your accountant. It is the shareholder agreement that will stipulate what happens when a partner dies and how a buyback will take place, so it's vital that it's set up correctly from the outset.

The sum that is insured is typically based on the amount of capital the remaining shareholder would need to buy out their colleague's equity in the company.

Risks of not having shareholder protection insurance

The risks of not having shareholder insurance

If a company owner dies without having pre-planned what happens next, their shares will usually go to their estate. They will then pass to the shareholder's family, who'll have two options:

  • Take over the deceased owner's position in the business
  • Sell the shares to another shareholder or a third party

There are numerous issues which could arise from these eventualities, but probably most significant is that the remaining shareholders could lose control of the company.

That could be to the family of the deceased or to a yet-unknown third party, either way, it could have serious consequences for the company.

Perhaps a lesser risk is that the surviving partners simply gain a sleeping partner, one who has shares in the business but plays no role in the day to day operations. While on the face of it this might not be problematic, it can lead to bad feelings towards each other, if one shareholder plays no active role yet still takes a share of the profits.

Finally, there could be unhappiness within the deceased's family if they feel they have no control over the business which they rely upon for an income. This could lead to disputes and disruptions within the business. As you can see, the death of a business owner can result in significant issues, which is why shareholder protection insurance exists, to minimise those as much as possible.

Have a question or want advice?

What are the benefits of shareholder protection insurance to business owners?

As we've outlined, shareholder protection cover pays out a lump sum to the business in the event of the death of an insured person, or their being diagnosed with a terminal illness (with less than 12 months to live). The primary benefits of this type of protection when coupled with a shareholder's agreement are:

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    Financial stability for both the business and the family
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    Removes the need for a business to save funds to purchase the shares
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    Remaining business owners can keep control of their firm
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    Avoids shares being sold to a third party and/or even a rival
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    Ensures a smooth transition of shares changing hands
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    Minimises business disruption
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    Provides beneficiaries with a clear understanding of how much money they will receive

How do we take out a shareholder protection policy?

There are three main ways that shareholder protection policies can be taken out:

  • Life of another policy - this method of shareholder protection is typically used when there are only two significant partners and they pay the premiums and own the other's life policy. Premiums are paid for by the individuals, not the company, which avoids certain inheritance tax liabilities should a claim be made. In the event that one of the shareholders dies or becomes terminally ill, a claim is made and paid to the owner of the life policy. That shareholder can then use the proceeds to purchase the company shares from the deceased's estate. "Life of another" policies are the most commonly taken out by small companies.
  • Company Share Purchase - with this method, the company pays the premiums and owns the policies. Should a claim be made, the company will receive the money and will then be able to purchase the shares from the deceased's family. The downside of this method is that it can become quite complicated from a taxation perspective, so we always recommend seeking independent financial advice if company share purchase is the route you wish to take.
  • Own life - the third and final way of taking out protection cover for shareholders is for each individual to take out an insurance policy and have the benefit placed into a business trust. In the event that the shareholder dies or becomes terminally ill (or critically ill if applicable), the proceeds will be paid into the business trust, accessible by the business, allowing the company to buy back the shares.

Cross-option agreement

As we have already mentioned, regardless of who owns the policy it's vital that a "cross-option agreement" (also known as a double-option agreement) is set up. It is an essential clause within a shareholder agreement that details exactly what should happen if one of the shareholders passes away. The agreement can be entered into by all of the shareholders and each will decide their "Relevant Proportion" (value) of shares. The shares can be valued in three ways, open market value, fixed value or fair market value. We'll be writing a follow-up article which explains each of these methods of valuation, but in any case, it would be wise to consult with your accountant and an independent financial adviser to make sure you value your shares accurately.

Cross-option agreement

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Best UK Shareholder Protection Insurance Providers

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Best UK Shareholder Protection Insurance Providers

Other Types of Business Protection

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About Business Protection Hub

We're experts when it comes to all types of protection insurance, working with companies all around the UK to help them find the right cover. We're proud to partner with market leading brokers, who are authorised and regulated by the Financial Conduct Authority and provide free, impartial professional advice to our customers. If you have any questions about the topics covered in this guide, then please get in touch using our quote form or call us on 01202 714178 - we're on hand ready to provide you with bespoke financial advice.

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