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.
This short 2 minute video sets out to explain the merits and virtues of keyman insurance and how and why it should be integrated into every company's business plan.
The example used is very typical and will surely resonate with all expat business owners.
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.
Deans personal account of the impact his stroke had on him and his business
A sole traders keyman insurance requirements
When a sole trader dies, the business dies with them. The business’s assets will form part of the sole owner’s estate and pass on to beneficiaries under the terms of their will. If the owner has not made a will, the laws of intestacy apply – in effect, the state lays down who the estate should pass to.
If the estate is large enough (in the UK and over £325,000 in 2016/17, including the value of any homes, business and other assets) and is not left to a spouse or civil partner, inheritance tax (IHT) is payable on all assets above £325,000. The good news is that most businesses are not subject to IHT.
Two issues however can arise:
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:
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:
A partnership insurance plan should always be in place
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.
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):
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.
Angry board members in dispute
Companies continue after a shareholder’s death, but the basic succession issues are similar to those facing a partnership. The key is to make sure that the shares end up with the surviving shareholders and that the deceased shareholder’s family receive the monetary value of those shares in cash.
Generally, the deceased shareholder’s beneficiaries will want financial compensation in return for their shares, assuming that they do not plan to continue in the business.
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 :
Partnership and shareholder cross-option agreements at work
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.
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