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The shareholder/directors in limited companies – and, indeed, members of partnerships – often need protection against the impact that the death of one of the shareholder/directors or partners might have on the financial viability of a business.
In general, most small companies provide in their deeds or articles of association that, on the death of any one of the principals, the others will have the right to buy them out – usually at a pre-determined price, or on an agreed basis. This is logical, since those who have invested time, money and effort in a business will often be reluctant to see a fresh face – however well intentioned – moving in to replace a valued member of the team, simply through inheritance. New ideas can be a good thing, but not if they adversely impact on the status quo at a time when the company has enough hurdles to overcome, as the result of the unexpected loss of a prime mover.
For this reason, shareholder/director or partners can arrange life assurance based on the amount that would have to be raised in order to “buy-out” the deceased participant’s share in the business. In this way, the death of a principal will trigger payments adequate to meet the cost of buying the share of the business inherited by the former principal’s beneficiaries. This sort of arrangement will normally include all the partners or shareholder/directors, although in some cases older individuals may be left out, if there is an alternative strategy for business continuity, such as the introduction of another individual from within the business with ownership remaining unaltered.
Life assurance policies can either be written on a cross-life basis, where each principal takes out a policy on each of the others, or by each principal on his or her own life, for the benefit of the others, under trust.
It is most common to use level term assurance for this purpose, possibly with a conversion or extension option. However, there is some merit in considering increasing term assurance, since the value of the business is likely to rise with time and a degree of inflation proofing at outset could save time and effort later on.
Within the context of shareholder protection, it is also worth considering that key man insurance can protect the business – and thus the financial interests of the shareholders – in the event of the death or long-term incapacity of certain key employees. These key employees may include – but are certainly not restricted to – the shareholder/directors.
Other forms of shareholder protection might include covering directors’ loan accounts with life assurance, so that, on the death of a director, money is available to cover the company’s liability.
The future value of investments is not guaranteed but may fluctuate and no decisions should be made relating to shareholder protection should be taken without seeking professional financial advice.