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What is shareholder protection?

17th Aug, 2016

By Robert Little

Very few business owners in the UK have a shareholder protection policy, yet this type of cover is incredibly important for businesses with more than one owner. In this post I will use a short case study to demonstrate the importance of this type of insurance policy.

Who needs shareholder protection?

Shareholder protection is vital for any Limited company, partnership or Limited Liability Partnership (LLP) with more than one owner or partner. If you are the only owner of your business then you should not require shareholder protection but other types of business protection could still be important. While the policy is called “shareholder” protection it is available to partnerships and LLPs as well as Limited companies. For the rest of this post I will use the term “shareholders” to refer to the owners of partnerships, LLPs and Limited companies.

What does it do?

It provides a lump sum if one of the shareholders either dies or experiences a serious illness (such as a heart attack, stroke or cancer diagnosis). This lump sum is paid to the other shareholders who can use the money to buy the ill/deceased shareholder out of the company.

Why is it important?

It can help to ensure business continuity and can stop any disagreements between the ill/deceased shareholder’s family and the remaining shareholders.

Case study

Mr Jones and Mrs Adams are shareholders and directors of a Limited company. Mr Jones owns 60% of the shares and Mrs Adams owns the other 40%. Both of them have a spouse and two children respectively. Their accountant tells them the business is worth £1,000,000.

Mr Jones passes away suddenly. His wife, Mrs Jones, inherits his share of the business, so she now owns 60% of the company shares. She has no interest in continuing to run the business and she would prefer to get rid of her shares. She asks Mrs Adams to buy her out. Mrs Jones speaks to the accountant and she is told the fair value for the shares is £600,000 (60% x £1,000,000) so this is what she expects to receive from Mrs Adams.

Unfortunately Mrs Adams does not have £600,000 available. However there is some money available in the company bank account. She asks the accountant about paying a lump sum out of the company bank account to help towards the share purchase. Unfortunately the accountant tells her that this is not possible – first of all it would be treated as a dividend and would be subject to dividend tax, which would reduce the amount she could receive. Second of all Mrs Jones (as a 60% shareholder) is entitled to 60% of any dividend payments. Both of these points mean the company would have to pay a dividend of far more than £600,000 for Mrs Adams to actually receive £600,000 and the company does not have this much money.

Mrs Adams then approaches a bank to ask about taking a personal loan of £600,000. Unfortunately the bank views the company as too risky and is unwilling to lend £600,000 (after all the majority shareholder has just passed away and this will leave a void in the business).

Mrs Adams tells Mrs Jones she will be unable to buy the shares. Mrs Jones looks for an alternative buyer and, eventually, a private investor agrees to buy the shares for £400,000 (a substantial discount to the fair value of £600,000). This private investor, a stranger, now owns 60% of the shares and has legal control over the company.

As an alternative to selling her inherited shares to the private investor at a discount Mrs Jones could have held on to them. Had she done this there would be no obligation for her to do any work to help Mrs Adams with the running of the business. Mrs Jones, as the majority shareholder, would have control over the company including the future dividend policy. She would have the power to appoint other directors even if this was against Mrs Adams’ wishes.

Summary

Without shareholder protection:

  1. The family of the deceased was forced to sell shares in the family business to a stranger.
  2. In the meantime there was a great deal of uncertainty for the family of the deceased and the remaining shareholder.
  3. The family of the deceased received far less than the true value of the shares.
  4. The remaining shareholder is left with a stranger as the majority shareholder in the company. This person is now legally in charge of the company, including the future dividend policy.

With shareholder protection:

  1. Mrs Adams would have received a lump sum of £600,000 following Mr Jones’ death.
  2. She would have used this money to buy Mrs Jones’ inherited shares.
  3. Mrs Jones is left with the fair value of her late husband’s shares and has no more concerns about the business in the future.
  4. Mrs Adams is left in 100% control of the company without having to take out a loan.

Advice

If you would like to discuss this type of policy with one of our advisers please visit our Contact us page or call 01642 477758.

We offer a free initial meeting to all new clients. If you then decide to proceed with an insurance policy we will receive a commission from the insurance provider and so you will not owe us a fee (although you have the option of paying a fee if you prefer).

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01642 477 758

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