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What is shareholder protection and why is it important for business owners?

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If your business has multiple shareholders, what would happen if a shareholder became seriously ill or passed away? It could place the business in a challenging position and affect long-term plans, but as a business owner, it may be something you’ve overlooked.

Thinking about a shareholder becoming ill or passing away isn’t a scenario anyone wants to consider. However, it’s still important to put a plan in place. By considering the risk now, you can take the necessary steps to safeguard the business should something happen. In some cases, shareholder protection can provide a vital safety net.

What is shareholder protection?

Shareholder protection can provide other shareholders with the funds they need to buy shares if one shareholder were unable to work due to a serious accident or illness, or if they passed away. It would pay out a lump sum, usually based on the capital the remaining shareholders need to buy the shares the outgoing shareholder has.

The premiums for this type of policy will depend on several factors, including the amount of capital needed and the health of the shareholder.

But why does shareholder protection matter?

Many businesses rely on their owners for direction and long-term security. If one of your shareholders were unable to work, how would it affect your business? It may mean certain decisions cannot be made or are delayed, affecting profitability.

In the event of death, a shareholder could pass their shares on to others through their will. This may mean the shares go to someone who does not have an interest in the future of the company, whose wishes do not align with other shareholders, or that the shares are sold to a third party. All these scenarios can put a business in a challenging position and even affect whether it continues to operate.

Shareholder protection can provide certainty for businesses during difficult situations.

A shareholder agreement can set out what happens if a stakeholder passes away, while shareholder protection can deliver the funds to ensure this happens. It’s a step that can help a business run with minimal disruption, as well as ensuring the shareholder or their family are fairly compensated for their shares.

Despite this, research from Legal & General found many business owners have not thought about these circumstances. Almost four in ten (37%) of businesses would want to purchase an absent shareholder’s shares, but many don’t have a plan in place. Instead, they’d have to rely on personal wealth. Worryingly, 47% of shareholders also said they’d left no instructions in their will or set out special arrangements regarding their business, potentially leading to uncertainty during the probate process.

Choosing the right shareholder protection for you

If shareholder protection could provide your business with security, it’s important to choose the right policy for you. A policy that suits one business, may be inappropriate for another. These questions can help you understand your options.

Which type of shareholder protection is right for you?

There are three main different types of shareholder protection to consider:

  1. A “life of another policy” provides each shareholder with their own policy. If one dies, a payout is made from the policy to the surviving shareholders. This type of policy is often used when there are two business partners.
  2. If there are several shareholders, writing individual policies into a business trust means the shares can be divided equally among surviving shareholders when someone passes away.
  3. Finally, policies held in a business trust can pay out to the business, rather than remaining shareholders.

How much cover do you need?

You also need to calculate how much you’d need to buy the shares. Valuing your company can be difficult but it’s an important step to take to ensure the level of cover you have is adequate. You will need to review the company’s articles of association to understand the value of shareholder protection insurance needed. Your accountant will often be able to provide support and advice when valuing your business.

Do you want the policy to cover critical illness?

All shareholder protection policies will provide cover in the event of death, but serious illness can also pose a threat to the business. Some policies will also provide protection if a shareholder is diagnosed with a critical illness that means they can no longer work. In some cases, critical illness cover isn’t necessary. However, it can provide an extra layer of protection for the business and financial security for shareholders should something happen.

What are the policy premiums?

As mentioned above, several factors affect policy premiums, but there are many providers. You should shop around for the best deal for your business, as it can help you find a policy that delivers the protection you need at a competitive price.

If you’re a business owner and are assessing your succession plan, please get in touch. We can help you select the right shareholder protection for you, as well as offer advice on other policies that could safeguard your business.

Please note: This blog is for general information only and does not constitute advice. The information is aimed at retail clients only.

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