Passing on a business after death

Supported by
Scottish Widows
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Supported by
Scottish Widows
Passing on a business after death
(Ellie Burgin/Pexels)(Ellie Burgin/Pexels)

Passing on a business to the next generation can be fraught with problems, some of which are business-related, such as whether the chosen successor is suitable or experienced, and some of which are financial. 

But if the person in charge dies suddenly their share is often left to a spouse who may not want to run the business. 

What types of protection cover are there to help other directors buy the share out and to ensure the long running of the business?

When insuring the owners of a business for life insurance there are some key things to be aware of, Kathryn Knowles, managing director at Cura Insurance, explains.

The main insurances are key person cover, shareholder protection, relevant life insurance, business loan protection and partnership protection, but there are three main ones to look at, Knowles says.

Key person

- Arranged to help the company cope financially with the loss of a key person.

- There is usually no point in arranging this for someone with more than a 5 per cent shareholding in the company. The Anderson principles dictate that you cannot access the tax advantages of this policy if you do so, unless you get specific permission from the local tax officer.

Shareholder protection

- Arranged to help the company pay the next of kin a fair value for the shares that the deceased owned. 

- Usually arranged under a cross-option agreement or buy-back option. There are key technicalities for the premiums and how the claim is handled, depending upon which way this is set up.

Relevant life insurance

- Arranged as a thank you to an employer of the company (this can be a director).

- This needs to be about a thank you for the service they have given to the company, it cannot be specifically arranged to cover a personal liability (though the next of kin might choose to use it to pay off a mortgage).

Knowles says: “There are a lot of tax implications on all these different types of cover, and this is just life at the moment, we haven’t even touched on the exec IP.

“It’s a very complicated area and it’s the area that firms engage with me most to train them on. Lots can go wrong.”

Ian Smart, product architect at Royal London, explains that where the business is structured as a company, a partnership or a limited liability partnership, insurance can be used to provide the other owners with funds to buy the shares of a shareholder or partner from their family.  

Alongside the insurance policies there will also be a cross-option agreement, which gives the surviving owners the option to buy and the family the option to sell the shares in the business.  

The policies will typically be taken out by each owner on their own life and put under trust for the benefit of the other owners. 

This makes sure that if an owner dies, the benefits of the policy can be paid to the other owners quickly and usually free of any taxation. 

If the other owners or the family exercise their option, the other party must then comply and either buy or sell the shares. 

This ensures continuity of ownership for the remaining owners, and that the family have a willing buyer and they receive a fair value. 

This type of arrangement is known as shareholder or partnership protection.

Sean Dunlop, protection proposition manager at Scottish Widows, says that when passing on a business to the next generation it is important that the business retains as much value as possible and is resilient to financial vulnerability.

He adds: "Setting up a five-year renewable policy to cover the loss of profits of the death of a key person, to pay off any outstanding commercial and director loans and provide money to cover share purchase costs, is crucial to ensure that value is retained for the next generation."

But there may be other problems the business now faces.  Any borrowing may need to be repaid.  

Smart says: “The business may run into short-term profitability issues while it recruits and trains someone to take over the duties of the owner that has died. The business can take out insurance against the financial effects of losing a key person, known as key person cover. 

“This would be taken out by the business on the life of the key person and provides the business with a lump sum should the key person die. It’s also possible to provide cover for a critical illness or to provide the business with an income in the event of temporary disability of the key person.”

In both cases it is important to make sure the right level of cover is put in place and that it is paid to the right person at the right time.

Key person insurance pays a sum of money to shield a business from the financial impact of a key individual dying or being out of action while they recover from a critical illness. 

But it cannot be used by directors to buy the share of the business held by another shareholder in those same situations, which is where the shareholder protection comes in.

Shareholder protection pays a lump sum that can be used to buy shares from the family of a director who has died or, in the case of a critical illness, from the director who wants to sell their shares and leave the business because of their poor health. 

Alison Esson, propositions manager at AIG Life, says it is something business directors really should think about, because a lack of succession plan can ruin their own financial legacy and the business they worked so hard to build. 

She adds: “Passing a share in a business to a spouse or children who are unlikely to have experience in running it is likely to put the business’s financial future at risk. Worse still, the shares could be sold to a third party such as a competitor. Shareholder protection helps avoid these scenarios, which is good for the business and the family.

“The family gets paid the shares’ value so they’re left some financial protection. The remaining director retains ownership and control of business, which means the business can continue in the right hands of people who know it best and who are best-placed to make the important decisions about its future.”