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Protection for life stages: Middle-aged business owners

19 July 2019

Two business owners aim to sell up in five years’ time, but haven’t considered if one of them died in the interim. What possible solutions are there?

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The circumstances

Rob and Peter have been running their business successfully for a number of years.

It's always provided them with a good level of income and they have discussed the possibility of selling up in the next five years (and certainly before they reach 60). It's a well thought-of business and they should have no trouble finding a buyer.

What they haven't discussed until recently was what would happen if either of them didn't make it to 60. They had always assumed the surviving shareholder would look after the family of the deceased, but had never really thought about how that might work in practice.

The challenge

Rob and Peter are not alone.

According to research, almost a half of business owners have no plans in place for the death of a shareholder, while a similar proportion have left no instructions in a will or any special arrangements regarding shares.

Possible solutions

The good news is that, provided Rob and Peter are in reasonable health, they have a few options.

If the plan is to sell the business in the next five years, they could each take out a five-year level term assurance policy for the value of their shares. They could write the policies in trust for the surviving shareholders using a flexible business trust, so the proceeds don’t form part of their own estate.

Another possible route would be for the company to take out five-year level term policies on the lives of the shareholders.

If, for example, Rob dies, the company can use the policy proceeds to buy his shares, which will then be cancelled. This leaves Peter owning all of the remaining shares in the business. This route requires no trusts, but does require that the company’s Memorandum and Articles allow it to buy its own shares.

There are a number of requirements that need to be met in order for this method to work, but it is often favoured by accountants. Because there is no personal taxation involved in paying the premiums, the amount of money required to fund them is lower than if they are paid from the shareholder’s net income.

Also, if the premiums are different because Rob and Peter are different ages, this method negates the need to equalise the potential benefits by making adjustments to their taxable income.

If there will only ever be the two shareholders, another method could be for both Rob and Peter to take out a policy for the same sum assured on a life-of-another basis. This too would negate the need for a trust but would also make it less flexible if another shareholder were introduced because they only sell part of the business initially, or if one decided to sell up and the other decided to stay.

Whilst insurance policies can generate the funds required to buy the shares from the deceased’s estate, they don’t ensure the transaction will actually take place.

In each potential solution outlined here, it’s imperative the shareholders have up to date wills. They would also need to put in place a suitable double option agreement. This enables either the surviving shareholders/the company or the executors of the deceased’s estate to exercise an option that forces the other party to buy or to sell the shares.

Without this, there is always the possibility that the advice given to effect the policy in the first place will fail.

Staying on

The level term policy arrangement would be practical and provide a solution only if they were to die within the next five years. What happens if they decide to continue for a few more years, perhaps because the market conditions aren’t right to sell the business? They might be left with no cover if their health has changed for the worse and they can’t rewrite the policies.

When deciding the term of the policy, they may want to consider using a renewable policy. This option would allow them to renew the policy at the end of the five years for a further five years, and keep the cover going for years to come (typically up until the day before their 90th birthday) if needed.

Of course there is likely to be an additional premium to pay for the feature but it might just be a price worth paying.