A Short Guide to Shareholder and Partnership ProtectionThe death or permanent incapacity of a shareholder or partner can alter the balance of power within your business and can create financial difficulties for the surviving shareholders, partners and their dependants. For example:
It is therefore in the interests of all stakeholders to plan and finance business continuation, in the event that a shareholder/partner dies or becomes critically ill.Shareholder ProtectionA business continuation agreement is drawn up between shareholders, setting out the rules for disposal of the shares of a deceased or incapacitated shareholder.The agreement is supported by a series of interlocking life assurance policies and trusts, providing the finance a tax-efficient buy out the relevant shareholding for its full proportionate value.
The "Cross Option" Shareholder Protection AgreementThe surviving shareholders have an option to buy ("call") the shares from the deceased/incapacitated shareholder’s executors, while the deceased shareholder’s executors have an option to sell ("put") the shares to the surviving shareholders.The agreement needs to specify the method of valuing the shares and the time limit for exercising the options which may differ for death and critical illness. The advantage of this arrangement over other versions of the agreement is that it preserves business property relief for Inheritance Tax purposes. Where the shareholder is insured against a critical illness, the agreement should define the circumstances under which the shares can be "called". For example, a minor heart attack will trigger a claim under a critical illness policy, but the affected shareholder may be capable or working normally. In such cases, it may be inappropriate to force the affected shareholder to sell. One solution is for the agreement to stipulate a double option (put and call) on death, and a single put option for critical illness, allowing the affected shareholder to decide whether to exercise the option.
Life Assurance and Trusts for ShareholdersEach shareholder insures his/ her own life in trust for the other shareholders. On the death/critical illness of a shareholder, the policy proceeds pass to the surviving shareholders and are used to buy the shares. Partnership Protection The mechanics of partnership protection are similar to shareholder protection. The Partnership Protection AgreementThe main forms of agreement are the aforementioned "cross option" and "automatic accrual".
Under automatic accrual, the partners agree to the automatic transfer of the partnership share to the other partners if a partner dies or becomes critically ill. Trusts for Partners Under a cross option agreement, each partner takes out a life assurance policy on his or her own life in trust for the surviving partners. On the death of a partner, the policy proceeds pass immediately to the surviving partners and are used to buy out the partnership share. Under an automatic accrual agreement, the life policies will be written in trust for the partner’s personal nominees. On the death of the partner, the policy proceeds go immediately to the deceased partner’s nominees via the trust, while the partnership share accrues automatically to the surviving partners.
There is no CGT on the policy proceeds in the hands of the policyholder, except when someone who is not the original beneficial owner acquires the policy for money or money’s worth. Your adviser will assist you with all aspects of setting up a business continuation arrangement - from the drafting of the appropriate business protection agreement to the calculation of the correct sums assured and the creation of trusts - to ensure that your business remains in the right hands and that your dependants realise the full value of your stake in the business.
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