As a business owner, you may have heard of the term ‘business protection’.
You’ve likely heard why you should have business protection in place but what exactly is it?
And why should you have it?
Put simply, business protection is putting a plan in place to protect a company and it’s stakeholders from financial shocks caused by something happening to the human assets of the business.
Generally speaking there are two types of business protection:
- Keyperson Protection
- Business Succession Protection
For the purpose of this article, we are going to focus on the succession planning element of business protection.
We will cover the key person protection element in another article in future.
This article will focus on Shareholder Protection and Partnership Protection.
The arrangement put in place for these structures are pretty much the same.
Issues you face as a Company Owners
Many problems can arise for a business when an owner or partner die prematurely or become seriously ill.
Surviving owners may have insufficient funds to purchase a deceased owner’s shares.
Many business owners believe their business partners will look after their families if they die.
What would happen if the surviving business owners were unwilling or unable to do this?
Ensuring the survival of a business in the event of a co-owner dying requires consideration.
As a business owner, you likely protect or insure the physical assets of the business, property, equipment etc.
You probably have car and home insurance, maybe even pet insurance.
Have you protected what is one of your most valuable assets, your shares?
Simply put, have you insured your shares?
Are the relevant provisions in place for the succession of the business in the unfortunate event a co-owner passes away or becomes seriously ill?
The Importance of a succession plan
The death or illness of a shareholder can cause immediate financial issues for the remaining owners.
It could even result in a loss of control of the company for the surviving shareholders.
On death, a co-owners shares usually pass to their next of kin.
The next of kin then become new shareholders in the business.
This can lead to problems for both the next of kin and the surviving owners.
The next of kin may not wish to become involved with the running of the company. They may want to sell their shares asap.
The remaining co-owners likely want to ensure they retain full control and ownership.
They may not want to work with a new shareholder, whether that be the next of kin of the deceased or someone who buys those shares.
Business protection helps avoid these problems.
Considerations
If you’re a business owner with business partners, consider the following.
If one of your partners were to pass away, their share of the business would pass to their next of kin:
- Would their next of kin (likely their spouse) be able to assume the role of a business partner?
- Do they have the knowledge and experience to become a partner in the business?
- How would you feel if their next of kin became a business partner?
- Would their next of kin have no interest in the business and look to sell the shares?
- If they would prefer to sell the shares would you and the remaining co-owners have the necessary funds to buy them out?
Consider the following if you were to pass away prematurely and your own next of kin was to inherit your shares:
- Would your next of kin (likely your husband/wife) be happy to take your role in the business?
- Do they have enough knowledge and expertise (and interest!) of the business to assume your role?
- Do they get on well with your existing business partners?
- Would they prefer to sell your shareholding and be financially compensated?
- If so would you like them to receive fair market value?
Generally speaking from the discussions we have with clients and contacts, number ‘4’ above is the most common.
The surviving spouse would prefer to sell the shareholding.
A formalised plan is required to cater for the above.
In the busy life of a business owner, this can often be neglected.
The consequences of not having business protection in place
If a business co-owner passes away:
- The remaining owners may not have the capital required to buy the deceased’s shares back
- As a result, they may be forced to take personal loans in order to retain ownership of the company
- If there is not enough capital they are forced to accept the next of kin as a new shareholder/co-owner
- The next of kin (potentially your spouse) may wish to sell the shares
- The next of kin (potentially your spouse) may not be able to get a fair price for shares on the open market
- A competitor of the company may acquire the shares
What is business protection?
Business protection is essentially a life insurance contract when combined with a formalised plan, protects against the above consequences.
It provides dual protection:
- It protects the surviving business co-owners and shareholders
- And it protects the deceased’s family and next of kin
It basically protects all stakeholders in the business.
The advantages of a business protection agreement to protect your shares
The main advantages of having a formalised plan are:
- A capital lump sum is provided to the surviving owners to enable them to purchase the deceased shareholder’s share of the business from the next of kin
- Practically – no new owners come into the business
- The surviving co-owners retail full control of the business
- The deceased’s next of kin can realise the full value of the deceased’s share of the business
- Your next of kin does not need to move into a business they may have no expertise or knowledge of and indeed no interest in
An agreement provides clarity on what happens should a business owner pass away.
Furthermore, it provides peace of mind for a business owner and a family that their interests are protected should this happen.
Review Your Existing Arrangements
One Solution
Let’s assume there are three company owners.
One solution is for the company to take out a life insurance policy on the life of each shareholder.
The policy covers the value of each co-owners share.
This then forms part of a share buyback arrangement entered into by the shareholders and the company.
Should one of the directors pass away, the policy pays out to the company.
The proceeds of the policy are then used by the company and surviving owners to buy back the deceased’s shares from the next of kin.
The share buyback agreement means the surviving shareholders are legally obliged to purchase the shares from the next of kin and the next of kin is legally obliged to sell.
This achieves the following:
- The surviving co-owners retain full ownership of the company
- They have the necessary capital to purchase the deceased’s shares from the next of kin
- The deceased’s next of kin has been fairly compensated for the business share.
Business protection is not about……
the sale of a life insurance policy.
Business protection is about…..
protecting your business, your family and your legacy.
It’ll never happen to me
It’ll never happen to me is a common train of thought when it comes to any type of discussion involving life insurance.
Unfortunately, the worst can happen to anyone.
We don’t like to consider our own mortality or the potential for illness but unfortunately, it happens.
According to Aviva, in 2020, the average age for a female life claim was 51.
The average age of a male life claim was 54.
Moving to New Ireland, Cancer accounted for 32% of life claims in 2020.
Heart issues accounted for 15% of claims.
The source of these statistics is both Aviva and New Ireland claims departments.
The important thing to take from this is that this type of event can happen to anyone, unfortunately.
To Summarise
I assume as a business owner you would like to protect your family and your legacy.
As a business owner business protection is an integral part of this.
Your company can cover the cost of this so there is no personal outlay and the buyback agreement is a legally binding document.
This ensures certainty at a traumatic time for both the family of the deceased and even the surviving co-owners.
Where your business provides for your family it’s essential you protect this asset.
How we help
We have helped many of our clients put in the correct business protection structures.
We do this by working alongside their accountants and tax advisers as a cohesive unit.
This allows our clients to get on with what is most important to them, running their business and spending time with their families.
Business protection is an arrangement that has to be regularly reviewed.
Some of our clients have come to us with arrangements already in place and they simply just needed them updated or a second opinion on them.
If you have arrangements in place and would like to review or update them or wish to discuss how to get protection in place, request a callback.
It’s important to note the above scenario is a guideline, it’s not a one size fits all solution.
The actual structure required is specific to each individual business and it’s important you take the relevant financial planning and tax advice on this, which is why we work alongside our clients tax advisers and accountants.
Alternatively call me on 086 0080 756 or drop us an email, francis@fortitudefp.ie.
We also have available a handy one page guide to business protection, if you would like a copy provide your details here.
Francis McTaggart CFP® SIA RPA QFA
These blog posts are intended for information purposes only and should not be interpreted as financial advice.
You should always engage the services of a fully qualified financial planner before entering any financial contract.
To discuss engaging the services of Fortitude Financial Planning please email us at info@fortitudefp.ie.
Fortitude Financial Planning Ltd will not be held responsible for any actions taken as a result of reading these blog posts.
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