Shareholders are an integral part of your company’s success. As such, it is wise to protect their shareholdings. Shareholder protection insurance is the best way to protect your and other shareholders’ interests in the company. This article explains shareholder protection insurance and how to value a business for shareholder protection.
What is shareholder protection?
Shareholder protection is an effective business continuity solution that allows shareholders to buy back shares from a co-shareholder who is diagnosed with a terminal illness or dies.
Usually, a shareholder appoints beneficiaries to their shares when they die or fall critically ill, but this can cause disruption to the business. The beneficiaries often lack the same skill set that made the shareholder a valuable partner. In addition, they may not share the same passion or intention to keep the business running. Surviving owners buy those shares to retain control of the company and avoid disruption. That said, remaining shareholders may lack the funds or borrowing potential to do so, and this is where shareholder protection insurance comes in.
Shareholder protection insurance is based on the lives of the shareholders. The shareholders take out life insurance equivalent to the value of their shares in the company. Critical illness covers can also be added or included as add-ons.
What are the types of shareholder protection insurance?
In the UK, there are three recognised types of shareholder protection insurance:
Life of another
These policies are straightforward and used when there are two or three shareholders in the business. A shareholder will own the policy of another, and the other partner will own theirs, and so forth. Should one shareholder die or become critically ill, the policy pays out to the other partners. They can then use those funds to buy out the affected partner’s shares. Premiums for these policies come from company funds post-tax, ensuring no tax liabilities on the policies. Life of another insurance policy works best for up to three partners. Beyond that, policy ownership becomes tricky.
Own life held under business trust
This is a simpler approach to ownership of the policies. Each person owns their life policy, but they are kept under trust. The value of each partner’s shares is written into the business trust, and when that partner dies, the trust pays that value to the surviving partners, who use the funds to buy out the deceased’s shares. Premiums for this policy can be a business expense. However, that leaves the surviving partners with a tax obligation. Thankfully, the partners can pay premiums from their post-tax gains to avoid tax obligations.
Company share purchase
The company takes out life insurance policies on each shareholder. The business is the policyholder, premium payer and beneficiary when a shareholder dies or becomes critically ill. In such an event, the company buys back their shares and dissolves them, thus increasing the remaining shares’ value. The premiums are not a business expense, thus saving the remaining shareholders from any tax obligation. However, tax compliance and other terms of this policy are complex. Therefore, you need professional help if you opt for this solution.
How to value a business for shareholder protection?
The value of the business determines the value of each share. Therefore, a simple way to calculate the value of the shares is applied to the business’s net profits. You need to work with your accountants and professional services to arrive at a reasonable multiple.
There are other ways to determine the value of the business, such as discounted cash flow. This method places the value of the business on expected future cash flows. It looks at the projected value of a business today based on how much money it can make in the future. You may also consider valuing the business based on multiples of net profit, cash in the bank, assets, and the business’s intangibles. Factors like business reputation and the strength of relationships with clients increase the value of the business.
Shareholder protection insurance is a critical consideration for the future of your business. It ensures business continuity when a shareholder passes on or falls critically ill by compensating the shareholder’s dependents and giving the remaining shareholders control of the business. You only need to know how to value the business to determine how much each share is worth. We understand the complexities of this process and have the expertise to reach a fair value. Contact us today to find out more about how to value a business for shareholder protection.