Till death do us part

When looking at the corporate business protection market, many advisers may focus on the traditional key person protection policies. These days, business protection has progressed far beyond this.

Comprehensive, bespoke business protection menu products now offer more targeted protection solutions for smaller firms. Although keyperson cover will provide financial compensation to the impact of the loss or illness of a key person to the partnership or business's bottom line, there may be other considerations following a tragedy. These solutions may also be available to partnerships.

The most basic of these is, what happens to the future control of a business in the event of the death or critical illness of a partner or major shareholder?

Understanding how share ownership protection works can enable advisers to help business owners safeguard the control of their business going forward. It is important to note that share purchase protection and proper succession planning is fundamental to the future growth of the business and it is important for the business owners to take proper legal advice throughout. For the purposes of this article we will use the term 'share purchase protection.' However, it is worth noting this refers to both interest in a partnership as well as to shares in a company.

So what type of businesses need to know about share purchase protection? The simple answer is all businesses, which are controlled by a limited number of partners or share-holders, where a family member will not simply inherit the business on death.

Succession planning

The most important aspect of share purchase protection is to ensure businesses have a formal arrangement in place, which maps out the plans for succession planning within the business. Without this, the share purchase protection cannot be put in place properly.

In most businesses, each partner owns a share of the capital and goodwill of the partnership and takes a share of the profits. In the absence of a partnership agreement, in the event of the death of a partner, the partnership is dissolved and the deceased's executors are entitled to the value of their interest. Most partnerships will want an agreement to provide that this dissolution of the partnership does not take place. If the partnership is to continue it is essential for the remaining partners to have funding in place so the value of the deceased's interest can be paid out.

In private companies there are often major shareholders who are also actively involved in the business. On the death of one of these shareholders, their share may pass according to the terms of their will to a surviving spouse or other family members. The new owner of the shares may not be willing or able to participate in running the company and may want to realise the value of their shares. The desirable route would therefore be for the shares to be bought from the shareholders by remaining shareholders or the company itself. This may also apply where the shareholder is not actively involved in the business.

In reality, however, few businesses plan for funding the share or partnership purchase. The co-owners can be left without the necessary funding and arrangements to ensure the future of the business. Similarly, business owners often fail to put into place measures that would enable them to purchase the share of a retiring co-owner. It is also good business practice to consider what might happen if a partner or major shareholder became critically ill.

The solution here is to ensure the remaining partners, shareholders or the company itself has the resources to acquire a partner's interest, or a member's shares ' therefore ensuring the control of the business is retained. An ideal way of doing this is through a life assurance policy, but crucial to the success of the arrangement is to establish well in advance the procedures to be followed, to ensure ownership changes can be implemented in the most appropriate way to the individual business, and also in the most tax-efficient way.

Life companies have a range of options available to meet these needs. Some can also provide guidance with sample wordings for the type of arrangement that a business should put in place ' a share purchase agreement. There is a range of different options, which have different tax implications and businesses may wish to take legal advice about which arrangement is best for them. A simple buy and sell agreement can provide a clear commitment, but this may have Inheritance Tax implications.

A double option agreement may be more tax-efficient. An 'automatic accrual' agreement can enable a partnership to provide cover against the death of one or more partners, while a single option agreement will deal with critical illness cover. With all these arrangements, there may be a requirement for trusts to be considered, to ensure tax efficiency and an unequivocal succession arrangement. Trusts are another area where care should be taken, as the arrangements in place may be irrevocable. Again, life companies can help, but legal opinion is essential.

The type of insurance policy that is taken out will depend on the chosen share purchase agreement. It is best to view this as a total package and while advisers have an important role to play in alerting business clients to the need to take out cover, and recommending a policy, it should be stressed that legal advice is essential.

While this might seem onerous, the end value of share purchase protection cannot be underestimated. Like many types of insurance, its true worth is often only fully appreciated when a claim is required. By helping clients put the right package in place, advisers can forge good relationships with business clients.

Raising awareness

It is common that small businesses do not have this type of arrangement in place, simply because they are not aware that this type of protection exists. Once an IFA has explained the potential consequences of not having share ownership protection, companies are generally keen to ensure they are protected.

One question, which is frequently asked by businesses, is whether the cost of business insurance is a worthwhile expense. This is a straightforward question for advisers to address. In an era where businesses spend considerable sums on areas of business development such as recruitment consultancy, training and personnel development, branding and so on, it is common sense to protect an investment by ensuring the business has the necessary funds in place to survive the loss of a co-owner.

One way of highlighting the potential consequences of not having cover is to look at the possible outcome of the company or partner being unable to fund the purchase of the shares or partnership in the event of the death of a co-owner. This would inevitably mean the person who inherited the share of the ownership would take the place of the deceased. Few small businesses would be enthusiastic about the prospect of an outsider entering the scene by default. In a small business, management is often the key to success, so retaining control of the business is essential following the death of a co-owner.

How much does share purchase protection cost? Companies should have an amount of protection that directly relates to the value of shares held in the company, which can be determined by independent valuation. For partnerships this should be the partner's share in the capital value of the partnership ' including undistributed profit and the value of good will. It is important for regular reviews to take place to ensure the amount insured keeps track with the growing value of the business. For most businesses every three or four years may be sufficient, but for fast-growing companies, more frequent updates may be required.

Sales opportunities

Once an adviser has become familiar with share purchase protection, they might find it an excellent source of business growth going forward. As previously mentioned, vast numbers of businesses and partnerships may not be properly protected ' or even if they do have protection in place, it may be some time since it was reviewed. Advisers might consider targeting the small business clients on their books, and doing a mailshot to raise awareness of the issue. This might be followed up by a seminar or client visits. The local Chamber of Commerce might be an excellent starting point for advisers looking to target new clients.

Share purchase protection is fundamental to ensuring the control of a business remains in the right hands should one of the co-owners die. The key is to ensure the remaining owners, or the company itself has the necessary funds in place to cover the value of the deceased's ownership of the company. A life insurance policy is an ideal way of doing this, but it is crucial to have a legal arrangement in place and formal procedures to follow which have been agreed in advance.

Many potential pitfalls exist and legal opinion is advisable here. Many small businesses may not have the right cover in place simply because they are unaware such policies exist. This presents valuable opportunities for advisers. Business protection is more than simply keyman protection and life companies are on hand to help advisers help their clients put these arrangements in place.

Heather Armstrong is head of marketing at Scottish Equitable Protect