A tricky shareholder protection case involving an older director with a serious heart condition and a healthy younger director, requiring careful consideration, knowledge and planning to reach a good workable final solution, while being careful to avoid a few banana skins on the way.
When our client approached us to help him find £500,000 life insurance, both he and we knew that it wouldn’t be easy. Aged 55 our client had severe artery disease, sufficient to have required a total of six stents to be fitted over a three year period. The client wanted to ensure that if he died his wife would receive £500,000 and that his 50/50 business partner would be left with 100% of the business.
We began by further researching the client’s medical profile and potentially available options with insurance company underwriters. A specialist insurer suggested they might be able to consider offering terms at an indicative premium of £1182pm, but we felt we could do better! Medical underwriting requirements included full GP reports with cardiologist letters and a medical examination. When final underwriting results came through we had managed to obtain terms at a premium of £365pm. Brilliant!
However the job was still not finished.
A further issue related to the valuation of the business which it turned out was worth significantly less than the amount our client wished his spouse to receive in the event of his death. We explained that there was a straight forward solution to this problem. Rather than conflate the need for a sufficient amount of death benefit for his spouse with the requirement to ensure that he and his business partner received each others shares in the event of death, we suggested he first take out a shareholder protection policy based on a fair and justifiable business valuation. The realistic business valuation given was £200,000 so we suggested a policy for £100,000.
Secondly we suggested he take out a separate life insurance plan for the benefit of his spouse as a Relevant Life Plan. Not only would he effectively pick up tax relief on the lion’s share of the total protection premiums but it also helped to significantly reduce the impact that ‘premium equalisation’ for shareholder protection would otherwise have had on his business partner, who of course would be liable for personal income tax on our client’s shareholder protection life insurance premiums paid for by the business. This was especially significant given that the premiums for his cover were 770% of the cost the premiums for his fellow shareholder, due to his business partner being significantly younger and with no rateable health conditions.
We also gave the client the option (which he took) of further increasing his total life cover by a further £100,000 bearing in mind how difficult it might be to obtain more cover in the future should his health change, as £600,000 was the maximum level the insurer could offer without the need for any further medical evidence.
We arranged the necessary policies for both him and his business partner (£100,000 shareholder cover and £500,000 relevant life cover each) and assisted our clients with the necessary trust documentation for all the policies, making sure that in the event of a claim the right amount of cover ended up in the right place quickly and without any further tax liability. We also provided them with a draft life company double option agreement for them to share with their lawyer.
A few years ago a bad thing happened.
We received a telephone call from a potential new client asking to cancel our appointment with him and his business partner because his business partner had died suddenly the day before. The purpose of the meeting had been to arrange some life cover for each of the two business partners so that if either of them died the other would be provided with enough money to buy out the other’s shares in the business.
However shocking the sudden loss of a close friend and business partner was, the troubles didn’t end there.
The family of the dead partner had never had any involvement in the day to day running of the business but of course they had depended upon the business for their income. What were they going to do now?
The two business owners had been skilled professional engineers and been responsible between them for most of the business reveue. With only one fee earner remaining the business faced significantly lower revenue meaning that the business could not continue to fund at the same level both sets of income – something would have to give.
How did this story end?
The remaining shareholder who was in his late 50’s and had been hoping to retire in a few years was forced to remortgage his own home to provide the capital necessary to buy out his ex business partner’s shares – putting up his own home as security was the only way he could raise the necessary required funds. Big change for him then and for his own family.
Here’s a thought – what if I said this man was lucky! How could that be? Surely he was unlucky?
Well obviously he was unlucky because he hadn’t put a robust disaster recovery plan into place in time and it ended up personally costing a him a fortune in added debt, delaying his retirement by years and putting himself, his family and his home at risk. The cost of the insurance premiums necessary to prevent this personal calamity would have been a fraction of what he ended up having to pay.
And the lucky bit? Well this all happened a few years ago at a time when he was able to raise sufficient extra equity from his property to finance the share purchase.
It could have been much worse – it could have happened now.
Because as we all know – right now persuading banks to lend money is a completely different proposition compared to a few years ago and likely to be even more difficult when the bank learns that the business has just lost a key person who was a responsible for a earning a significant proportion of business revenue. Put bluntly for a great many business owners the answer right now is going to be no.
And then what? A forced sale to a third party perhaps?
If you a have any concerns about protecting your business and your assets why not contact us at Moneysworth 0845 430 5200. We can help you take back control and make a plan to insure against the huge costs and risks of this future potential catastrophe for your own business.
It has all the hallmarks of a classic taboo subject – business owners know that there is a risk to their business lurking in the background somewhere and evertime they think about it they feel vaguely uncomfortable. But the easiest thing for a business owner to do is to move swiftly on to something else. After all its not exactly a problem today and it might not even happen………
So what’s taboo? Death of course, or rather death and serious illness. To be more specific its the effect that these two events can have on a business, especially small and medium sized businesses.
If you want some proof how about this for a stat – ”39% of business owners expected their businesses to fold within the death or critical illness of a business owner”.
Here’s another one – ”58% of businesses had no formal agreement to establish what would happen in the event of the death or critical illness of a business owner”.
[source – Intsitute of Directors and Legal and General – Business Protection Research]
‘Does it really matter?’ you might ask.
The question can be answered both quantitively and qualitively.
First the numbers – according to mortality data at http://www.actuaries.org.uk/ the following is true. Take a business with three male shareholders all aged 40 – the chances of one of them dying before the age of 65 is 19%. Thats quite scary – its going to happen a lot! The chances of one of the same three suffering a critical illness before the age of 65 is 64% – and thats very scary, a probability rather than a possibility.
But the qualitive answer is perhaps even more worrying. Because most people tend to ovoid spending time thinking about this issue, they do not consider the potential consequences. These could include but are not limited to the following
1) The bank might seek to call in personal guarantees regardless of the wishes of the business owners (and yes that could mean your home is at risk).
2) The business trying to raise a significant loan to buy out the shares of the deceased party
3) The business owners may have to try to raise the money required from personal assets such as the family home
4 The business taking on considerable new loan costs to repay the loan
5) At the same time the business suffering a fall in income and profits as a result of the loss of the business owner
6) Therefore the bank may not even agree to fund the share buy back, especially if trading conditions are not ideal, or if the bank lending is constrained due to general economic conditions
7) In the absence of commercial funding being available to the company or the remaining shareholders the family holding the estate of the shareholder may be forced to seek an external third party share purchaser
As someone who has faced this situation in business in real life I can assure you that these sort of risks are very real and potentially very damaging. In our particular case it was serious illness rather than death. Our first thoughts were obviously with the shareholder and his family -thank goodness he made a recovery, though it took some (very worrying) time before he knew that this would be the final outcome. During which time not surprisingly he decided that his priorities had changed and he no longer wanted to be involved with the business. Luckily for us we had the correct life/ critical illness policies and legal agreements in place which meant that at the right time the required funds were in place to finance the share purchase and with no need to take on additional debt. At the same time our eyes were opened to the consequences of how differently things might have turned out had we not been properly insured.
Here’s an odd thing – most businesses think nothing of insuring their business premises for fire. They don’t do so because there is a high risk of the insured event actually occuring, they do it because of the size of the potential financial consequences for the business that would follow a fire. Literally a fire could destroy an unprotected business.
So given the fact that the death or critical illness of a business partner or shareholder is so much more likely to actually occur it might be said that any of the 58% of businesses with no plan referred to in the research (above) are very playing with fire. Sensible action would be to take expert advice on the matter before its too late.