Farsight Financial Planning

Financial Blog
By Dominic Bowers, 12/05/2015
a picture inside a high rise meeting room
a picture inside a high rise meeting room
Owning and running your own business can be one of the most rewarding things in life and when things go well there can be nothing better. When things go wrong you will usually face up to the challenge and overcome it. But let me start by asking a quick question. Of the following which event would have the greatest impact on your business?
Business Meeting
  • A company car gets stolen
  • Your premises are vandalised
  • Your mobile phone is lost or stolen
  • The photocopier breaks down
  • You or your co-owner suffers a heart attack or dies

As with most businesses in the UK you probably have some form of insurance cover in place that will deal with the first 4 points. But what about the last point??

One of the most damaging events that can happen to a business is for the death or long term illness of one of the owners. It may not happen but to illustrate the point; if there are 3 owners in your business and all are aged 45, then there is a 31.2% chance at least one of them will die by age 65 (Source: Vitality Life). In terms of serious illness a non-smoking man has the following chances of suffering a critical illness in his working life – 1:8 chance of cancer, 1:16 chance of heart attack, 1:48 chance of a stroke and a 1:3 chance of suffering any critical illness.

When it comes to distributing shares, is a surviving spouse going to want the shares, or are they going to want to cash them in? The remaining shareholders would probably prefer to purchase the shares from the spouse, but what if they don’t have the necessary funds? This is just the scenario where Shareholder Protection can be very useful.

So what is Shareholder Protection?
A Shareholder Protection arrangement simply ensures that proceeds are available when required (either on death or serious illness), so that there is a smooth and stress-free succession. It involves setting up legal agreements between the shareholders that sets out how the shares will be dealt with upon death or serious illness. In conjunction with the legal agreements a series of insurance policies are taken out on the lives of the shareholders in order to ensure that if the worst happens the funds are in place to buy the affected shares. Should an owner die, or become seriously ill, then the insurance policy can be used to purchase the shares.

What are the benefits?
  • A stable business should the worst happen – in today’s fast moving world it’s vitally important that any business has a stable business plan. If a shareholder were to suddenly die, or become seriously ill, the short term uncertainty could certainly cause harm to the future running of the business. By putting in place a legal succession plan, with the appropriate funds in place, even if the worst were to happen the remaining owners could use the proceeds to buy the shares very quickly and not have to worry about having to find the money. Instead they are able to get on and run the business.
  • Support for family – If one of the shareholders were to die then it’s more than likely the remaining family members wouldn’t want the pressure of owning shares in the business. In all likelihood they would want to receive the cash in what would be a very difficult time in their lives. More often than not the business owner who has died would have been the main breadwinner in the family and the extra cash would help massively in those circumstances. As the legal agreements and insurance policies have been put in place beforehand the payout can be made with the minimum of fuss or stress.
  • Illness/disability – As mentioned earlier Shareholder Protection can also help in the event of an owner suffering a serious illness. Very often these sudden serious illnesses cause people to re-evaluate their priorities. It may be that having suffered an illness the shareholder would prefer to walk away and spend time with their family. As long as the correct agreements have been put in place it will give them the opportunity to sell their shares to the remaining owners.

Let me finish by showing an example. If a shareholder were to die, or suffer an illness or disability, where would the business get the money to buy the shares?

Option A
Option B
£500,000 loan (as an example) Interest rate 6%
Monthly interest of £2,501
£500,000 sum assured via insurance policy (as an example) Life cover only (£54.90 monthly)
Life and Critical Illness (£300.60 monthly)

This is based on a healthy male, non-smoker, aged 45.(Rates are sourced from Assureweb on 8/5/15).
Risks:
Considerations:
Will the finance actually be available?
Will need to be underwritten first.
The capital above will need to be paid back.
Need to ensure cover level matches value of shares.
Business value and profitability could be at risk.
No capital to pay back.
May need to provide personal security for loan.
As with any policy exclusions and limitations may apply.


Which situation would you rather be in?
The legal agreements are usually very straightforward to put in place and once the insurance cover is put into place the whole package ensures that should the worst happen there is a very good chance the business will be able to get back to doing what it does best.

As ever, if you need to discuss any financial planning issues then get in touch for a no-obligation chat.