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Business protection basics – what you need to know as a business owner

People are at the heart of every small business. However, whilst most business owners know to insure their stock and other physical assets, the key people driving a business forward are often overlooked in this respect. This can be a very costly mistake where, for example, a key director or employee dies or suffers a critical illness unexpectedly.

Below, we take a look at shareholder protection, cross-option agreements and key person insurance

Shareholder / partnership protection

Shareholder and partnership protection provides an agreement between the directors or partners in a business, supported by life assurance, to ensure that there are sufficient funds for the survivor(s) to purchase the shares of the deceased.

It is designed to ensure that the control of the business is retained by the remaining directors or partners but the value of the deceased’s interest in the business is passed to their chosen beneficiaries in the most tax-efficient manner possible.

If a shareholding director or partner were to die with no agreements in place, the implications for the business could be very serious indeed. Not only would there be a loss of experience and expertise, but consider, too, what might happen to their shares.

The shares could pass to someone who has no knowledge or interest in the business. Or you may discover that you can’t afford to buy the shareholding. It’s even possible that the person to whom the shares are passed then becomes a majority shareholder and so is in a position to sell the company without your consent or involvement.

Cross-option agreements

By taking out a ‘cross-option’ agreement you will determine what will happen to the shares in the business if one of the owners were to die or become critically ill. It is important that this agreement is not binding regarding sale of the shares, because this will prevent you from claiming relief from inheritance tax.

Essentially, the shareholding directors or partners in a business enter into an agreement that does not create a legally binding obligation on either party to buy or sell the shares but rather gives both parties an option to buy or sell. For example, the remaining shareholder has the option to buy the shares of the deceased shareholder from the exectutors and, likewise, the executors of the deceased shareholder have the option to force a sale of those shares to the remaining shareholder.

In either case it is the exercise of the option that creates a binding agreement; there is no binding agreement beforehand. This type of agreement is generally called a ‘cross-option’ agreement and can be a very effective instrument in dealing with the orderly succession of an owner-managed business.

Key person insurance

Key person insurance is designed to compensate a business for the financial loss brought about by the death or critical illness of a key employee, such as a company director or other integral member of staff. It can provide a valuable cash injection to the business to aid a potential loss of turnover and provide funds to replace the key person if appropriate.

How could my business benefit from key person insurance?

You cannot replace the loss of a key person, but you can protect against the financial burden such an event may cause. In drastic cases, you could risk losing your business if you do not have the right cover in place. Key person insurance can be utilised in a number of different ways – for example, to repay any loans taken out by the key person; to help recruit and fund the training costs for replacement staff; to meet the ongoing expenses while the level of sales recover; or to facilitate payments for outside consultants or expert advice that may be required.

There are various types of insurance to choose from, including life cover only, critical illness cover, or combined life cover and critical illness cover. You can select different levels of cover and terms depending on your specific requirements.

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