Shareholder protection exists to protect both the company and shareholders’ families. In the event of death or diagnosis of a specified illness of a shareholder, shareholder protection ensures that the remaining shareholders have the right and the resources to buy back the share from the deceased shareholder’s family. While the family also has the right to insist that the surviving shareholders buy the shares in the event of death or critical illness. It ensures that the family receives a fair price and that the remaining shareholders retain control of the company.

The Policy

Any policy each shareholder effects should be set up in a discretionary Trust.

It is essential that Shareholders first make individual Wills to specify who should inherit their share of the business.

Shareholders should then enter into an agreement, called a Cross-Option Agreement, which provides the basis for the share purchase and details how the purchase can be made.

Cover can be arranged for a fixed term or on a whole of life basis. This means that cover would continue until a claim is made and at normal retirement age, the policy would then be assigned to the individual. However, this option always costs more than simple term assurance and the premiums are not guaranteed throughout the term of the policy.

The sum assured should reflect the individual’s share in the value of the business. Each policy should then be effected with a sum assured of reflecting that percentage value held in the business.

In its simplest form, cover is paid on the death of the life assured. Cover can also be effected to pay out if the shareholder suffers a critical illness, which may prevent them from working in the business.
 
The Agreement

Most surviving shareholders would want to buy their deceased Co-Shareholder’s shares and keep control of the company. The life assurance policy noted above would ensure that the surviving shareholder has sufficient funds to purchase these shares, but it is the Cross-Option Agreement that will allow the surviving shareholder to buy the shares or, for the deceased shareholder’s beneficiaries (or Estate) to sell them.

Business Property Relief from Inheritance Tax is lost if shareholders enter into a buy/sell agreement which is a binding agreement on both parties meaning that beneficiaries effectively receive cash (which is always subject to IHT) rather than shares. Using the cross option agreement means that beneficiaries must first receive shares from the deceased’s estate before any option is exercised and therefore BPR would still apply.  

In the event of a shareholder’s death, the agreement provides the surviving shareholder with the option to demand to buy the shares, and the deceased’s beneficiaries the option to demand that the surviving shareholder buy them. The surviving shareholder can exercise their option within 3 months of the date of death. The deceased’s beneficiaries can exercise their option within six months.

When new directors join the business, a supplementary agreement and an additional life assurance can be effected and a new director included in the agreement.  The agreement lasts indefinitely but should be regularly reviewed along with the level of cover.

For more information on shareholder protection and how it could benefit your business, contact Prosperis director Niall Gunn on 0113 287 8200.