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Expat Financial Planning Solutions

Providing Clarity For Investors Since 1985
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Shareholder & Key-Person Business Protection

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Preventing the collapse of companies in the event of serious illness or death

Owning a business can be a very rewarding experience. But what happens if a business owner dies or falls seriously ill ? Much will depend on the type of business that you have and its legal entity.

The most common structures are – sole trader, partnership or limited company – but unless there has been some advance planning, the chances are that what remains may simply collapse or worse still end up in the wrong hands.

If you are a business owner, business insurance is vitally important – it is simply the process of planning for what you want to happen if you or your co-owner (if you have one) die or fall seriously ill.

What happens when a business owner dies depends on the type of business.

    Types of businesses

     

    • A sole trader's business automatically comes to an end. The business may still have a value – stock, buildings, or assets such as equipment and vehicles and goodwill, but the business itself will legally cease.
    • A partnership may come to an end if the partnership agreement does not set out that the business should continue - its a sad fact too that most partnerships fail to even effect a partnership agreement.
    • A limited company continues but the shares held by the business owner will pass on to beneficiaries through their estate.
    • Keyman / Key Person Insurance - watch our keyman video guide below to understand the 'why and 'how of this essential cover
    • Dean Stockwells personal video account of the impact his stroke had on him and his business is essential viewing for all business owners

    Dean Stockwell - a managing director aged 47 never expected to suffer a stroke

    As a relatively young, fit and healthy managing director the last thing on Dean Stockwells mind was having to deal with the consequences of an unforeseen stroke.

    Issues for sole traders

    sole-trader-keyman-insurance

    A sole traders keyman insurance requirements

    The solution

    In both of the instances above, the requirement is for a lump sum of money to be created, preferably outside the estate (to minimise IHT).

    This can be achieved through a suitable life insurance policy. Generally we recommend that the sole trader takes out a life insurance policy on their own life and either assigns it to the beneficiary or sets up a trust to pay the beneficiary on their death.

    The exact solution depends on a number of factors, but here are two examples:

    • James, who has no close family, wants to leave his engineering business to his production manager Ken. Ken would not be able to buy the business’s assets on death, nor could he afford to pay the life insurance premiums. Instead, James takes out a policy on his own life, in trust for Ken. On James’ death, Ken has a lump sum to be able to buy the business assets and continue running the business, now under new ownership. Having this arrangement also gives Ken a strong incentive to remain with the business, and is valuable as a succession planning tool.

    • Melanie plans to leave her shop to her daughter Sam, but calculates that on her death IHT of around £200,000 would be payable on the rest of her estate. She is concerned that Sam would have to sell or mortgage the shop in order to pay the IHT bill, so she takes out a life insurance policy on her own life and assigns it to Sam. Sam then pays the premiums and, on her mother’s death, has a sum of money she can use to pay the IHT bill.

     

    Issues for partnerships

    A partnership is a business owned by two or more people. Unless specific provision is made in the partnership agreement (and very many partnerships have no formal agreement), the partnership will cease on the death of a partner. When that happens, the deceased partner’s estate becomes entitled to their share of the business.

    This can mean a choice:

    • The remaining partner or partners pay the deceased partner’s estate a sum of money agreed to be the value of the deceased partner’s share.
    • The surviving partner or partners and the deceased partner’s beneficiary carry on in business together – perhaps with the new partner having little interest or skills in the business.

    For example, John and Jane are in partnership and Jane dies. Jane’s sole beneficiary, her daughter Kylie, is keen for the business to continue, and so is John, who could not afford to buy out Kylie’s interest anyway. Unfortunately, Kylie is unable to play any active part in the business, and John resents having to split the partnership’s income with a sleeping partner who contributes nothing other than capital to the business.

    The solution

    Two main options are available to meet such needs, and are illustrated below using the example of a simple two partner business owned by A and B. (Other options are available, but are generally not as attractive):

    • A double option agreement - Under this agreement, the surviving partner has the option to buy the share in the business from the deceased partner’s estate – in other words, they can make the estate sell the share. The deceased partner’s estate can also exercise an option to force the surviving partner to buy. There must be an agreed basis for valuing the business.Generally, each partner takes out a life insurance policy on their own life, written under trust to benefit the other partner. So if A dies, B can decide to buy out A’s share from the proceeds of the policy on A’s life.

    • Automatic accrual - On A’s death, the business passes automatically onto B. No buyout is involved. Instead A’s beneficiaries get the proceeds from a life insurance policy A took out on his or her own life, written in trust for his or her beneficiaries.

    The end result of both solutions is that the remaining partner continues to run the business and the deceased partners’ beneficiaries receive a fair price. Without these arrangements, the business could be in danger and the beneficiaries might receive little or nothing.

    Issues for limited companies

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    Angry board members in dispute

    The solution

    A double or cross option agreement is often used for company shareholder succession planning.

    If shareholder A dies, their beneficiaries can require the remaining shareholders to buy them out or the remaining shareholders can require the beneficiaries to sell their shares.

    To provide the funds, each shareholder takes out an own life policy written under a special business trust to benefit the other shareholders.

    An example of such arrangement :

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    Partnership and shareholder cross-option agreements at work

    Serious illness

    It is not just the death of a business owner that can stop a business. If a business owner suffers a critical illness such as a heart attack, stroke or cancer, it may not be possible to continue in the business either temporarily or permanently.

    A suitable critical illness insurance policy is probably the best way to provide protection against the financial consequences of having a serious illness. These policies pay a cash lump sum on diagnosis of a specified critical illness or disability.

    The policies are normally written in trust for the other business owners, and there needs to be a formal legal agreement between the business owners about the circumstances in which the share in the business should be transferred.

    What should i do now ?

    Further resources

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    Video Updates - Watch and listen to our Discretionary Fund Manager (DFM) partner videos. The videos provide an insight to the managers thoughts and feelings in respect of market events alongside specific details on portfolio performance
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