Why is shareholder protection important for business owners?

Shareholder protection is important for protecting your company after you or another co-owner passes away – without it there are risks to the company’s future. In this article we look at what these risks are, how protection can help avoid these in the long run and the options available for setting up protection.

The risks of not having protection

If you or any other co-owners in your business were to die, any of the deceased’s shares could be passed on to the next of kin. This poses several potential risks to the company.

They could become involved in business decisions without having the necessary skills or expertise. They could sell the shares to somebody who isn’t qualified, or even to a competitor. And if the remaining owners wanted to issue dividend payments, these would also be paid to the beneficiary, even if they aren’t involved in the day-to-day running of the business.

But this situation can also pose risks for the beneficiaries. For example, there is no guarantee that they will receive the full market value of the shares if somebody else offers to buy them.

Shareholder protection can help

Directors may believe that they are protected from these risks as long as their company’s ‘articles of association’ state that on the death of one or more shareholders, the surviving shareholders must buy their shares. But what if there isn’t enough money available to buy the shares at market value?

Unfortunately, this is all too common. I recently spoke with five people from an IT company. Each held a 20% stake in the company, which was valued at £2 million – but there was only £250,000 in the business bank account. I asked them how they would find the extra £150,000 to buy the shares if one of them died.

In this case it may be possible to apply for a bank loan to buy the shares, but this isn’t always possible. The death of a co-owner or other significant person can disrupt or potentially shut down a business. Banks are aware of these risks and may not be willing to loan the money if they are concerned about repayment.

What are the options?

There are three ways to set up shareholder protection. The first is to use a ‘life of another’ policy. This is typically used when there are only two shareholders. Both take out a life insurance policy and name the other as the beneficiary – so if they die, the remaining shareholder will receive the proceeds and can use the money to purchase the deceased’s shares from their next of kin.

Where there are more than two shareholders, a better option may be to set up own life policies held under a business trust. Each shareholder takes out insurance on their own life and the company pays the premiums. The death benefits are written into a business trust with the other shareholders named as trustees. Upon a shareholder’s death, the lump sum will be paid to the trustees and can be used to purchase the deceased’s shares.

The third option is a company shares purchase agreement. The company takes out life insurance policies on all of the directors and receives the proceeds upon one of their deaths. The company then buys the shares from the beneficiaries and cancels them. However, this isn’t always the best choice – businesses should be more than five years old before considering a share purchase agreement as the purchase could be liable to Capital Gains Tax for younger companies.

Reviewing your company’s protection regularly

The value of your business (and your shares) will change over time, so it’s important to review your level of shareholder protection regularly. This can help to ensure that there will not be a shortfall when it comes to purchasing the deceased’s shares, and also that you are not paying premiums for a level of cover that you don’t actually need.

Speak to an expert

If you want to know more about shareholder protection or you know your business isn’t protected against these risks, you should speak to a financial planner. They can talk you through the options and recommend the most suitable course of action to protect you and your business – if necessary, working with your accountant and other professional advisers.

If you want to speak to a financial planner about shareholder protection, call us on 020 7189 2400, email contact@tilney.co.uk or click here to book a no obligation consultation.

Find out more in our business protection guide

If you want to learn more about how you can protect your business, why not download our guide? It explains some of the risks you may not even be aware of and everything you need to know about safeguarding your company from them.