Financial protection is a crucial part of the financial planning process for businesses. However, it is one area that is often forgotten about. This could have the potential of causing huge problems for the running of the business if one of the owners – a shareholder or partner – dies or is seriously ill.
Tax and legal experts surround most businesses, but the role of the financial adviser remains essential. Without sound financial advice on how to cope if illness or death should suddenly strike then companies’ plans for the future are not complete.
Stage 1 – establishing the facts
When an intermediary first meets a business client, as part of the fact-finding process it is worth drawing up a list of what they see as their main assets and what they think are possible threats to their business.
Main assets will usually include equipment, information, reputation and goodwill, money – including credits, debits and share price, people, premises, and systems.
Possible threats would be competitors, reduction in turnover through reduced sales, computer viruses, sudden loss of a key employee, fire or flood damage to premises, telephone line failure or power failure, and change of ownership after the loss of a partner or shareholder.
Stage 2 – addressing the problem
The intermediary should assess each of these areas and ask what the client has done to ensure their assets are protected and if they are prepared for any threats. Most businesses will have information security, a disaster recovery plan, and sales and marketing plans in place for future growth of the business. These plans will cover the majority of areas which have been identified in stage one. However, it is unlikely that the client will have planned or even thought about the consequences of a partner’s or shareholder’s death or serious illness.
Stage 3 – consider the consequences
“What if” scenarios are a good place to start and are a useful tool to encourage individuals to accept the implications of the unexpected happening.
For example, if one of the partners or shareholders died, what impact would this have on the business? There are several possible outcomes. The deceased’s family might have to sell their newly acquired share of the business. This might not be the best solution for the business, especially for the remaining partners or shareholders. If they need to take on another partner to help financially, the person who can afford to buy into the company might not be the most suitable person – they could even be a competitor.
If the person who has died is the main shareholder and the remaining shareholders cannot afford to buy his shares, control of the company could go to the new buyer. Or beneficiaries of the deceased partner might want to be involved in the running of the business, against the wishes of the other partners. If the remaining shareholders cannot afford to buy the shares from the beneficiaries of the deceased shareholder, and they do not have a market for the shares, they might have to pay some of the profits to the beneficiaries without them taking on any of the workload.
Another possible scenario would be the impact of one of the partners or a shareholder in the company suffering a serious illness. In this case, the business might have to be run without one of the key people who contributed to its success. If the person suffers, say, a heart attack, it is unlikely that they would be able to return to work for a long time, if at all. However, they may still expect to receive an income from the business without being able to contribute. This could severely impact the running of the business.
By having death or critical illness insurance on the life of the partners or shareholders these problems can be avoided.
Stage 4 – choosing the cover
Once it is established that there is a need for business protection, it is up to the financial adviser to ensure clients have the right protection for their needs.
Many individuals do understand the need for simple death benefit. However, this does not mean they will have any in place. Most prefer to bury their heads in the sand and believe that dying young will happen to someone else. This attitude is dangerous for anyone with dependants and is worrying when external parties such as partners’ or shareholders’ lives are involved. All businesses need to take into account how they will survive if a partner or shareholder dies.
In the same way as working out the implications of death, the intermediary needs to ensure that their business clients are also protected against serious illness. With advances in medical science in recent years, there has been a huge increase in the number of people surviving a serious illness. However, this might not be in good health or the recovery might take a long time. If the person that has been struck down by illness decides that they will not return to work, by having protection in place the business can carry on with the minimum of financial upheaval.
Stage 5 – implementing the solution
Deciding on the type of protection to best suit clients’ needs is not the end of the selling process for business protection. It is essential that the necessary steps have been taken to ensure that any payout from the protection plan is used correctly.
Financial protection for a business can be set up in a number of different ways depending on the type of business. To understand these fully it will be best to look at shareholder protection and partnership protection separately.
There is more than one way to set up shareholder protection, and the simplest method is for each shareholder to set up an individual plan. This would involve a protection policy being put in force by each shareholder on an ‘own life’ basis for the value of their share in the business. The shareholders would then write each of their policies under trust for their co-shareholders. By doing this, if one shareholder dies or becomes critically ill, remaining shareholders would have the funds to purchase the shares from the ill shareholder or from the deceased’s family.
Writing the policies under trust ensures that the cash ends up in the right hands at the right time. Many life assurance companies offer specially worded business trusts for use in these situations. The main difference between a business trust and one used for personal protection is that the business trust can have a ‘revert to settlor’ clause without compromising the inheritance tax efficiency of the arrangement – this is because it is part of a commercial arrangement. This is extremely useful as it means that once a shareholder either retires or ceases to be a shareholder he can take the policy away with him and use it for the protection of his own family.
As well as setting up protection policies each shareholder will need to enter into an agreement that will ensure their shares are purchased by the other shareholders if they die or become seriously ill. A cross option agreement will normally be used in these circumstances, and is best drawn up by the company legal advisers. But specimen wordings are available from many protection insurers.
There are two widely used solutions for partnership protection. The first is similar to the individual solution detailed above under shareholder protection. The partners each buy a protection policy, which will be put under trust for co-partners. As with shareholder protection, a cross option agreement will need to be entered into to ensure that the partners will be allowed to purchase the shares.
The second way to set up partnership protection is by automatic accrual. This will ensure that if a partner dies, their interest in the business will automatically transfer to the remaining partners. No payment will change hands for this type of arrangement. However, the family will receive the payment from the life insurance plan set up by the deceased partner on his/her own life. To ensure this happens, the policy will need to be set up in a gift trust.
As with all business planning, care should be taken in setting up the arrangements in the most tax efficient way. Here again, help is at hand and most protection insurers will be able to offer specialist tax advice to help the adviser ensure that the solutions are set up in the most tax efficient way. As always, this will often depend on the individual circumstances of the business concerned.
Partnership and shareholder protection is an essential part of business planning to ensure that the ownership remains with the intended people and they will be able to carry on running the business as intended.
Once the arrangement is in place, the intermediary should carry out regular reviews to ensure that the protection plans continue to reflect the true value of the business. If the value of the business increases over time, or more partners have become involved, additional protection will need to be arranged. Accordingly, a flexible protection plan will be an important part of ensuring that the business protection remains up to date.
The benefits for businesses in having an intermediary set up a business protection programme are obvious. For the intermediary, the business protection programme provides an ongoing opportunity to write very high value protection business, not just at the outset when the programmes are set up, but also as the intermediary’s business clients prosper and grow.