Shareholder Protection Insurance

How would you sum up what shareholder protection does?

It’s an insurance arrangement so that if a shareholder dies or potentially becomes critically ill, a policy can pay out to the business or a trust for the shareholders. Ultimately, it allows those shareholders to buy the shares back from the estate or from an individual to retain ownership.

Either the late shareholder’s estate – or the unwell shareholder – gets fair value for what they’ve built within the company.

How does this work for minority shareholders compared to majority shareholders in the UK?

For minority shareholders, we’re looking at the value they have within the business based on a relatively simple valuation.

Obviously, minority shareholders hold less power because their shares are worth less.

But those shares will have a value, so we need to assess that and apportion it according to the split of the shareholding.

How do you calculate the amount of shareholder protection needed?

The underwriters have a standard methodology, which takes an average of the last three years’ net profit before tax. Then a profits to earnings ratio is applied – which is typically one to seven times. If the ratio is one, you’re dropping profitability year on year; if it’s seven, you’re growing quickly.

There’s an element of discretion there. Then you add net assets on top of that valuation, and it’s split according to the percentage shareholdings. However, that’s not massively robust and we do recognise that.

If you go to an accountant or a financial advisor that can give a more industry specific valuation, potentially EBITDA-based or using other methodology, that can be used.

A recent example is where we arranged shareholder protection for an accountancy practice. Our methodology came out with a value of £3.75 million. But that didn’t reflect that they had recently acquired another business, which would bump their numbers up quite considerably. They worked out a valuation of £6 million and, as chartered accountants, the underwriter was happy with the calculations – so it is possible to take a different approach.

Most clients don’t go to that level because an accountant will want payment for a valuation, which is understandable. There’s some flexibility with insurers, but our method is the baseline. If you want something more specific, accountants can give more clarity.

How much is shareholder protection insurance?

We can’t put a specific value on the premium, because it fluctuates based on the value of the business and the type of cover. It could be life only, or life and critical illness. The latter is more expensive.

Premiums will also be influenced by the ages of each of the shareholders, whether they smoke, their medical history and BMI. Many different factors play into it.

A 25-year-old who’s completely healthy, doesn’t smoke, has a good BMI and owns part of a low value company will have a cheaper premium than someone who’s 65, has a shareholding worth millions of pounds, smokes and is overweight.

How is shareholder protection taxed?

That’s one to speak to your accountant or tax advisor about. It’s really dependent on which of the structures we use, and also the company.

You could be a single UK limited company, or you could have shareholders outside of the UK. You could have investors… lots of different things could impact the premiums, the payout and the tax.

What are the key benefits of shareholder protection?

The major benefit of shareholder protection is that you have a succession plan in place for when someone passes away or becomes unwell and you need to buy the shares back.

When I speak to accountants they invariably say that a low percentage of their clients have a shareholder agreement, and we find the same. That means there’s no clarity around what happens if shareholders want to sell the business or take a dividend.

You need to know what you will do if a shareholder dies or becomes ill. You probably have an idea – and it’s best to put it into a legal document to rely on if things don’t go to plan.

You’ve demonstrated how a business protection advisor can help. Is there anything you’d like to add?

Typically we don’t do this for companies in their first few years, as there may not be much value in the business at that point. They’re growing rapidly and might not even be making any profit. There could be value from year three onwards, typically, or later.

At that point it can be quite important. You may have got away without this for a long time, but perhaps you’re now gearing up for a sale. If you don’t have protection in place and something happens, there could be a dispute around the shares with a widow or a widower. Not having a legal framework or protection could completely derail the sale of that business.

You should put shareholder protection in place from the point where there’s demonstrable value. Different structures can also influence the importance of this. If you’re the sole shareholder, it’s not that important. The shares would naturally go to your next of kin.

But where there are multiple unrelated people involved, there can potentially be disputes around the shares and how to buy them back. It’s just a very clearcut way of mitigating that risk for a business.

Key Takeaways:

• Shareholder protection is a set of policies, typically life or life and critical illness insurance, that ensures the business has funds to buy back shares from a shareholder who dies or becomes critically ill.
• The insurance must be paired with relevant legal documentation, such as a Shareholder/Partnership Agreement and a Cross Option Agreement, to define the terms of the share buyback and make the transaction legally binding.
• The most common structure is Own Life in Trust, which offers flexibility in maintaining the policy’s validity even as shareholders join or leave the business.
• The legal agreement should outline a clear valuation methodology, often involving an independent chartered accountant, to ensure the insured amount keeps pace with the business’s growing value and to address potential shortfalls.
• The major benefit is establishing a succession plan, which is particularly important for businesses with demonstrable value and multiple unrelated people involved, mitigating the risk of disputes and potentially safeguarding against derailing a future business sale.
  
  

 Business protection policies are subject to underwriting, policy definitions, exclusions, and insurer terms and conditions. Tax treatment depends on individual circumstances and may change in future. Business Protected does not provide legal or tax advice. For specialist tax advice, please refer to an accountant or tax specialist.