What happens when a small business owner dies?

The sudden death or critical illness of a founder can have unwelcome consequences for a small business. Your SME could pass into the hand’s of an unwelcome family member or even be sold to a rival. Shareholder Protection Insurance allows you to plan your succession as you want.

The sudden death of a business owner may destabilise a business and can quickly lead to financial difficulties. Surviving business owners could lose control of a proportion or, in some circumstances, all of the business. The family may choose to become involved in the ongoing running of the business or could even sell their share to a competitor. This is where Shareholder Protection Insurance steps in.

According to financial advisers, Drewberry, half of small businesses do not have the legal structures needed to make sure they can buy a colleague’s share of the business from their family when they die. For many SMEs, that means the possibility of losing control of the business.

Only 43pc of business owners have any business life cover in place in the event of their death or incapacity.

What is Shareholder Protection Insurance?

Shareholder Protection Insurance allows the remaining partners or directors to remain in control of the business following the death of a business owner. If there is no share protection in place, the owner’s share in the business may be passed to family members uninvolved in running the business.

A share protection policy can help avoid these issues by providing the funds to purchase shares and also a suitable mechanism for the existing shareholders to retain ownership of the business.

Shareholder Protection Insurance protects a business and its shareholders by making succession planning as smooth as possible should a company shareholder die or become critically ill.

  • It provides the necessary capital for the remaining shareholder(s) to buy the deceased’s share of the business
  • The business can continue trading as normal whilst the deceased shareholder’s family can realise the value of their business interest
  • More than half of businesses have no formal agreement to establish what would happen if a business owner dies

How would Shareholder Protection Insurance help my business?

According to Legal & General’s State of the Nation’s SMEs report:

  • 53pc of businesses would cease trading in under a year if a key person died or became critically ill
  • 60pc of businesses had not reviewed their company agreements in the last year.

If a business partner dies without making specific provisions for their share of the business their interest in the company will likely pass to their estate. The family then has two alternatives:

  • A member of the family could take over the deceased’s position as a partner
  • The family could realise the value of the business interest by selling it.

Neither of these avenues is problem free.

► Losing control of the business

If a member of the family takes over the deceased’s position as a business shareholder, there is no guarantee that they will be able to make any contribution to the business. In fact, in some cases their presence could even be detrimental to the company.

► Sleeping partner

A sleeping partner who is not involved but is entitled to a share of the profits may be a huge burden to the remaining partners.

Alternatively, the family may be unhappy if it turns out they’re put in a position of having no effective control over the profits of a business which they may be relying on for income.

►Selling to an unwelcome party

If the interest is sold, the remaining partners may find themselves working with an unwelcome new partner. Or indeed there may be no natural buyers, in which case financial problems may surface not only for the family but also for the business.

What Does Shareholder Protection Insurance cover?

►Shareholder Life Insurance

Should a shareholder die or suffer a terminal illness (diagnosed with less than 12 months to live) a shareholder protection policy would pay out a lump sum to the other shareholder(s).

►Adding Critical Illness Cover to Shareholder Protection

Adding Critical Illness Cover enables the plan to pay out if the shareholder were to suffer a serious illness, the three most common claims are for:

  • Cancer
  • Heart attack
  • Stroke

In addition to the “big three” conditions, Critical Illness Cover covers typically anywhere between around 20 to more than 100 serious illnesses including conditions such as multiple sclerosis and motor neurone disease.

What is a Cross-Option Agreement?

A Cross-Option Agreement is set-up alongside Shareholder Protection, which on death provides the option for the other shareholders to buy the shares (“call” option) and the option for the deceased’s family to sell (“put” option).

Should the shareholder suffer a serious illness only a “put” option exists, giving the shareholder who has suffered the critical illness the option to sell their shares to the other business owners but not the right for the business itself to buy the shares. This protects a shareholder absent through illness from being forced out of the company.

It’s essential that the company’s articles of association give both parties the option to buy/sell the shares rather than an obligation. (An obligation to sell the shares could result in an inheritance tax bill as this may disqualify the shares from business property relief [BPR]).

There are two types of option agreements you would use for Shareholder Protection Insurance:

►Double Option Agreement

Also known as a Cross-Option Agreement, whereby the outgoing and remaining shareholders both have the option to buy/sell but where one party wishes the sale to go ahead the other must comply.

►Single Option Agreement

This is used when Critical Illness Cover is included in the policy. It still gives the insured (i.e. critically ill) shareholder the option to sell their shares but doesn’t give the remaining shareholders the automatic right to buy the shares. This protects the critically ill shareholder from being forced out of the business during their absence.

How does Shareholder Protection Insurance work?

  • A claim is made
  • When the policy is written under trust, the insurer pays the cover amount to the trust, with the trustees being the remaining shareholders
  • The remaining shareholders use the money to buy the deceased/critically ill shareholder’s share of the business
  • The deceased stakeholder’s family or the critically ill stakeholder receives the money from the sale of the shares.

How much does Shareholder Protection Insurance cost?

The below table details the monthly cost of shareholder insurance split into life insurance and life Insurance with critical illness cover for a healthy non-smoking individual aged 35, 45 and 55.

They’re looking for £150,000 of level cover (i.e. cover that will remain fixed throughout the policy term).

Age5-year policy10-year policy15-year policy
Cost of shareholder protection life insurance
Age 35£6.21£7.10£7.88
Age 45£10.51£12.66£13.73
Age 55£21.40£26.78£33.55
Cost of shareholder protection life and critical illness cover
Age 35£27.51£32.56£35.89
Age 45£59.38£71.21£81.25
Age 55£130.40£158.57£179.15
Premiums current as of February 8th 2019
Source: Shareholder Protection Quote Engine by Drewberry

See also: Drewberry Shareholder Protection Quote Engine

Do I need to consult a financial adviser?

When there are multiple shareholders with different holdings and various ways of structuring the protection, it can start to get complicated quite quickly.

Given the potential complications, you may want to use a specialist insurance broker, like Drewberry Insurance, to advise you on your policy options and compare quotes on your behalf.

Further reading

Can you afford not to offer business medical cover to your staff?