Ensuring the sustainability of your business
Business Protection Insurance
Many small business owners and directors understand the need to protect their business premises and equipment. However, many forget about their most valuable asset – their fellow directors and their key employees.
The death or critical illness of a key employee or co-owner can seriously impact a business, financially as well as the loss of key knowledge. That can directly affect the bottom line.
Business protection insurance protects a company financially when its owners or employees are affected by illness or death. It can help support owners in making sure their business survives those challenging times and ensure the long-term financial stability of the business for the benefit of the owners and all the staff alike.
Business Protection policies can be taken out to protect businesses of all sizes and types – including limited companies, sole traders, partnerships, and limited liability partnerships (LLPs).
There are two solutions for key person protection for companies:
a) life of another
b) own life in trust
Under a life of another policy, the company takes out a plan on the life of the key person. If the key person suffers a critical illness or dies, the policy will pay out directly to the company. The funds can be used to meet the company’s financial needs while it reorganises or recruits a replacement. In the case of a critical illness claim, it's possible the key person will return to work, so the funds can be used to pay for a temporary replacement or replace lost profits.
Under an own life trust, if the key person is a shareholding director, they can take out a plan on their own life and write it into trust for the benefit of the company. The potential beneficiaries of the trust would be the other shareholders. In the event of the key person passing away, with a suitable shareholders agreement in place, the remaining shareholders can use the policy pay out to fund the purchase of the shares.
In the event that the shareholder suffers a critical illness, the other shareholders will receive the proceeds of the plan from the trustees and can use those additional funds to inject additional capital into the business to for example, pay for a temporary replacement or to reorganise.
Limited liability partnerships
A limited liability partnership is similar to a limited company in that it has a separate legal persona. Accordingly, it is possible for a limited liability partnership to take out a plan on the life of a key person in the same way as a company.
There are two different solutions for partnerships depending on whether the key person is a partner or an employee.
Where the key person is a partner, they can take out a plan on their own life and write it into trust for the benefit of the other partners in the firm. Usually, the other partners in the firm will enter into reciprocal arrangements. In the event of death or diagnosis of a critical illness of one of the partners, the proceeds of the plan can be paid to the remaining partners.
Where the key person is an employee, the partnership itself cannot take out a plan on a life of another basis, this is because it is not a distinct legal entity in England and Wales. However, one of the actual partners can take out a plan on the life of the key person and write the plan into trust for the benefit of the partners in the firm.
If the key person suffers a critical illness or dies, the partners can receive the plan proceeds from the trust in exactly the same way as if they had passed away as stated above.
A sole trader may need protection for both themself and/or a key employee. A sole trader can take out a plan on their own life and write the plan into a discretionary split trust for the benefit of their family. This will ensure that in the event of death, their family will have funds available to settle any business liabilities like, for example, a business loan. The split trust contains a carve-out provision so that in the event of the settlor of the trust (in this case the sole trader) surviving diagnosis of a critical illness by 30 days, the proceeds of the plan will be held for the settlor. In this case, the sole trader can then meet the financial responsibilities of the business.
Where a sole trader also employs a key employee, they can take out a life insurance policy on the life of that other key person so there are funds available to meet the financial responsibilities of the business in the event of the key person’s death or critical illness.
Ownership Protection Insurance
The loss of a partner, member or shareholder can have a major impact on the success of a business in terms of ensuring continued control for the remaining owners.
Individual purchase arrangement
Under an individual purchase arrangement, each business owner takes out a protection plan on their own life for the value of their share of the business. The plans are written into trust for the benefit of the other shareholders, members or partners.
In the event of the death or critical illness of one of the business owners, the others will receive the proceeds of the plan from the trust to enable them to fund the purchase the shares of the deceased or a critically ill business owner.
Alternatively, if there are only two or three owners it is possible for each owner to take out plans on each other’s lives so that in the event of one of the owners dying or suffering a critical illness, the proceeds of the plan will be payable to the surviving business owners.
In both cases, it is recommended that a cross-option agreement is made between the business owners in order to regulate the sale and purchase of the share of the business.
A cross option agreement provides that on death or critical illness of a business owner, the deceased’s personal representatives have the option to sell the deceased business owner’s share of the business and the surviving business owners have the option to buy it thereby ensuring the continuing viability of the business.
Company share purchase
The rules are strict but it is possible for a company to purchase the shares of a deceased or critically ill shareholder. In this situation, the Company would take out a plan on the life of the shareholder so that in the event of their death or critical illness, the proceeds of the plan would be payable to the company enabling it to purchase the shares of the deceased or critically ill shareholder.
For exactly the same reasons stated above, a cross option agreement should be made between the Company and the shareholder to ensure the continuing viability of the business.