The financial and ownership problem
When a shareholder in a private company dies, their shares normally pass under their will or intestacy, often to family members who may not want, or be suited, to an active role in the business. The family may want cash rather than shares; the remaining owners may want control but lack the funds to buy them out.
Shareholder protection cover is one way to provide money at the point it is needed, so a sale can happen at an agreed value if the parties have agreed to it.
Valuation and review
The sum assured is usually based on the value of each shareholder’s interest. Valuing a private company is not straightforward, and an accountant’s input is often helpful. Values change as the business grows, so cover that matched last year’s valuation may be too high or too low today. Regular review is important.
Who owns the policies and receives the proceeds
Common structures include each shareholder taking a policy on their own life held in a business trust for the other shareholders, or the company itself owning policies to fund a buy-back of its own shares. Each route has different implications for who pays, who receives the money and how the purchase happens.
The right structure depends on the number of shareholders, the company’s articles and existing agreements, and legal and tax considerations.
Cross-option agreements, in outline
A cross-option agreement is commonly used alongside shareholder protection. In broad terms it gives the surviving shareholders an option to buy, and the deceased shareholder’s estate an option to sell, rather than creating an immediate obligation. This is a general description only, not legal advice; a solicitor should draft and advise on any agreement.
Including critical illness cover
Critical illness cover can be added so that money is available if a shareholder is diagnosed with a specified condition meeting the policy definition. The legal agreement then needs to deal with what happens to shares in that situation, which is different from death. Adding critical illness raises the cost.
Trusts and premium equalisation
Where shareholders own policies on their own lives in trust for each other, premiums can vary widely because of age and health. Some businesses consider premium equalisation so that no shareholder unfairly subsidises another. Whether this is appropriate, and how it is treated, needs professional advice.
Departures and changing ownership
When a shareholder leaves, new shareholders join or shareholdings change, the policies, trusts and agreements may all need updating. Arrangements that are not kept in line with the shareholder register can leave gaps or produce unintended results.
Underwriting and exclusions
Each insured shareholder is underwritten individually. Terms may differ between shareholders, and one may be offered cover with a loading or exclusion while another is not. Policies have exclusions and conditions, and accurate disclosure matters.
