What is shareholder protection insurance and why do you need it?

26th February 2020

What would happen to your business if a shareholder in your company died, leaving their estate to loved ones who now have a say in how the company is run? Without the right protections in place, you could find yourself in a difficult predicament. While people often prioritise life insurance to make sure their family is looked after should the worst happen, the same type of protection for businesses is often forgotten about. In this guide we’re explaining what is shareholder protection insurance, why you need it and how it works. 

what is shareholder protection insurance and why do you need it?

What is shareholder protection insurance?

The death of a shareholder is one of the most worrying things that can happen to a business. As well as providing equity, shareholders are often key decision makers within an organisation and their death can have serious consequences for any surviving shareholders and employees. The loss of a colleague, friend and leader within your business is already a distressing and traumatic time. Shareholder protection insurance helps alleviate some of the stress during an already difficult period and provides peace of mind that business can continue with minimal interruption.

Example: SJD Builders Ltd has three shareholders. Mr Smith is the managing director and runs the business alongside minority shareholders Mr Jones and Mr Davies. When Mr Smith dies, his estate is left to Mrs Smith, who is now the majority shareholder. None of the shareholders had considered what might happen in the event of their death and there is no protection in place. Unfortunately there are now several possible scenarios which could damage the business:

  • Mrs Smith wants to sell her shares to the remaining shareholders, giving them total control over the business, however Mr Jones and Mr Davies don’t have the funds to buy them from her
  • Mrs Smith sells all her shares to a third party, forcing Mr Jones and Mr Davies to work with someone who is able to do what they like with the business without consultation
  • Mrs Smith decides she would like to be involved in the running of the business, despite not having the expertise or knowledge to do so and makes decisions which prove detrimental
  • Mrs Smith wants to keep her shares but isn’t interested in being involved with the running of the business, meaning she is entitled to the profits without putting anything in

Unfortunately these scenarios are not uncommon. Although we have used a husband and wife for this example, the same can apply to any beneficiary. In fact, in many situations the shares are left to multiple parties, resulting in even more confusion and opportunities for things to go wrong.

Shareholder protection insurance ensures that in the event of a shareholding director there is a plan in place for the continued running of the business and the surviving shareholders are able to purchase the equity of the deceased. This means that:

  • Funds are available to allow the remaining shareholders to purchase some or all of the shares from the deceased’s estate so that they can retain control of their business
  • The family/estate of the deceased shareholder are able to sell their shares in the business for a fair value
  • The arrangement is set up in the most tax efficient manner

How shareholder protection insurance work?

The easiest way to think of shareholder protection insurance is to imagine it as a bit like life insurance for your business. In the event of a shareholder’s death, it provides a lump sum payout to either one or multiple named beneficiaries so that they have the cash to purchase some of all of the shares from the deceased’s family or estate.

Shareholder protection insurance can be complicated to set up and ensure all the correct agreements are in place. Premiums are calculated using a specific formula and an expert will be able to make sure you the correct amount of cover and trusts are in place to avoid paying inheritance tax, as well as a legal agreement for the sale/purchase of a deceased director’s shares.

What other cover is available?

Another type of cover to consider is known as a “relevant life plan”. These policies provide a lump sum benefit on the death of a director or employee outside of a registered group life scheme, with premiums paid by the company.

Relevant life plans are ideal for:

  • High-earning employees who have substantial pension funds and don’t want their death-in-service benefits to form part of their lifetime allowance
  • Small businesses that don’t have enough eligible employees to warrant a group life assurance scheme
  • Directors of small companies who want a cost-effective way of providing life assurance

These policies are tax-effective as the premiums are not usually subject to income tax as they are not assessable as a benefit in kind on the director/employee and can be treated as an allowable expense for the company in calculating their tax liability, potentially reducing tax on business profits. What’s more, in most cases the benefits are paid free of inheritance tax – provided they are paid via a discretionary trust.

The benefit is separate from any pension in place – payments don’t count towards an employee’s annual pension allowance and won’t form part of their lifetime pension allowance either.

How we can help

It’s essential that you get expert advice before setting up any of the above policies to ensure the correct arrangements are in place and tax-effective. Get in touch with our team for further support on how to ensure your policies are achieving maximum tax efficiency.

Did you know that you can get financial advice through our sister company, Key Wealth Management? The Key Wealth team offer practical advice on both business and personal financial matters with the same friendly and professional approach you’re used to from TTR Barnes. Our partnership means we are perfectly placed to offer a one-stop-shop financial and accountancy solution to our clients, giving you the peace of mind

Chartered Accountants in Sunderland, offering expertise on everything from Tax and Business Planning,
to Accounts and VAT.