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What is shareholder protection insurance and how does it protect your business?

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Michael Brown

Acting Editor

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The loss of a key shareholder in a business, whether big, medium or small, can have a ripple impact on its day-to-day running activities. This is why taking out a shareholder protection insurance can help mitigate some of these effects.

Below we have explained what shareholder protection cover is, and what type of arrangements are best suited for you.

What is shareholder protection insurance?

If a business loses a key shareholder, a shareholder protection policy will help the business’s remaining stakeholders buy out the outstanding equity from the outgoing shareholder’s estate. While this may sound complicated, the reason for doing so can help keep this business successful.    

Consider this example. The owner of a medium-sized enterprise suddenly dies and leaves his shares as part of his estate. This is ultimately inherited by his family who have no interest in the day-to-day running of the business and would prefer to sell this equity immediately.

Naturally, the family could sell this equity back to the company’s remaining shareholders, which could provide its own challenges. The business may not have enough cash to buy these shares out, or some of the remaining business owners may not be interested in increasing their equity. Otherwise, the family could sell out to a third-party investor, but this could lead to the family selling out for a reduced rate to get the deal completed quickly.   

However, in this scenario, if there was a shareholder protection policy in place the insurer would pay out an agreed upon rate to the remaining shareholders who would use this financing to purchase the outstanding equity from the deceased owner’s estate.

Ultimately, the owner’s family is left with a lump sum of money instead and the remaining shareholders have the peace of mind knowing how the company will operate in the event of the owner’s death.

Can I get shareholder protection insurance with critical illness cover?

Yes. This is something you can arrange with your chosen provider and will essentially allow the beneficiary to sell their shares if they were to fall critically ill and become unable to fill their role.

If you are unsure whether this cover is right for you, then speak to our preferred financial advisers Watts Mortgage & Wealth Management.  

Who pays for the shareholder protection premiums?

The company will cover the cost of a shareholder protection plan. This can therefore be used to cover multiple different prominent shareholders if necessary.

How are shareholder protection premiums calculated?

Like life insurance, a shareholder protection policy’s premium will be based on several factors to determine the risk for the insurer. This includes, but is not limited to, the insured person’s:

  • equity in the business
  • medical information and history
  • age
  • lifestyle (for example, whether they exercise or smoke regularly).

In addition to the total value of the business, the insurer may also analyse its projected profit and loss statements.

What are the tax implications of a shareholder protection policy?

For the business, paying a premium for a shareholder protection policy can be listed as an expense and, as a result, is exempt from corporation tax.

As for the payout, if the shareholder were to die their inheriting family will not be subject to inheritance tax if their policy is written into a trust. If this is not the case, the tax implications could become more complicated and would rely on the shareholder protection arrangements, which are explained in more detail below. If you are unaware of how your shareholder protection scheme pays out, speak to a qualified specialist today.  

Finally, most payouts are also exempt from capital gains tax. This is because the price of the shares is agreed upon before entering the policy and therefore they do not gain any value when they are sold.

What are the benefits of shareholder insurance?

A shareholder protection policy can have a range of benefits for the business as well as the outgoing shareholder’s beneficiaries.

It offers the business the peace of mind that if it was to lose one of its primary shareholders then the company should know how to function in their absence. In addition, as mentioned, without a shareholder protection policy the business might find it difficult to find the funds to purchase back these shares. As mentioned, this runs the risk that the outgoing shareholder’s beneficiaries might sell this equity to a third-party investor. For the remaining shareholders, it means that they may lose control on their portion of the business and it could disrupt the management hierarchy.

For the shareholder’s beneficiaries, the policy offers them a guaranteed buyer for the inherited equity. This is particularly beneficial for those who do not wish to play a role in the inherited business.  

What type of shareholder protection arrangements are there?

The cross-option agreement

As one of the more common shareholder protection arrangements, a cross-option agreement can be set up between the business’s remaining shareholders and the insured shareholder’s estate. Also known as the double option agreement, this will stipulate who will purchase the shares from the insured shareholder’s estate and at what price.

Both parties are therefore given the choice to exercise their option to sell or buy these shares. It is key to note in this agreement that if either party triggers their option to buy or sell the shares, the other party must follow suit.

The buy and sell agreement

The buy and sell agreement ensures that the remaining shareholders must purchase the equity held by the outgoing shareholder. This differs from a cross-option agreement as the transfer of shares must happen and is not triggered by either party.

Company buyback

This option is more complicated than the cross-option or buy and sell agreement. This essentially requires the business to buy and then cancel the shares from the outgoing shareholder. This allows the company to allocate these shares to another investor when the time is right or allow the existing shareholders to carry on with the day-to-day running of the business.  

The automatic accrual method

This is a niche shareholder protection arrangement which is only available to partnerships. In essence, the automatic accrual method is an agreement in which the outgoing partner’s equity is immediately transferred to the remaining partners. So, since the shares never form part of the partner’s estate, their beneficiaries should look at a comprehensive life insurance policy to ensure that they are properly compensated.

Disclaimer: This information is intended solely to provide guidance and is not financial advice. Moneyfacts will not be liable for any loss arising from your use or reliance on this information. If you are in any doubt, Moneyfacts recommends you obtain independent financial advice.

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