Succession planning is a concern for any family company, especially in the first generations. As well as the worry as to whether younger family members will want to join the family business, there is the concern as to what if something happens to a senior member of the business when younger family members are still learning the ropes.
There are insurance products that can provide a financial safety net for family businesses in the unfortunate event of the death or serious illness of a person key to the running of the business.
Without these policies in place, an unexpected death or serious illness could cause a business financial uncertainty or even worse, failure, as many businesses simply do not have the ability to keep going, either while junior members learn the ropes or to keep the business running so that it can be got ready for sale. Capital may be needed to pay loans or buy back shares at short notice or an outside manager brought in.
According to statistics, up to 46% of UK businesses would be forced to cease trading immediately if a key person died or was unable to continue working through critical illness or injury.
Key Person Insurance
Key person insurance is simply a business insuring itself against the financial loss it may suffer as a result of the death (or critical illness if chosen) of a key person employed by the business.
The key person can be any key person, but in a family business is likely to be the chair or managing director.
All that is needed to prove that someone is a key person is to show that their death (or critical illness if chosen) would cause financial loss to the business. This can be shown through examples such as a loss of profits, having to retrain and recruit their replacement or even customers losing their confidence in the business as a result of their death.
Key person insurance is especially recommended where a family business is relatively new or limited in the number of personnel, as the staff will be the business’ greatest asset – the policy will be the ‘key’ to the business’ survival should the worst happen.
After submitting a claim, a lump sum is payable to the business to help it stay afloat, which can then be used for essential costs, including staff replacement costs, repaying capital or loan repayments.
The policy should be written in trust so that the proceeds will, generally, be paid out free of tax.
Shareholder Protection Policy
In order to be able to keep a business within a family, a shareholder protection policy provides a pay-out to allow family members to purchase the shares of a shareholder on their death (or critical illness) if whoever inherits the shares does not want to be involved in the family business.
Each business owner normally takes out a life insurance policy (with the option of critical illness cover) on their own lives, written in trust for the benefit of the other partners or share-holding directors (the beneficiaries).
A cross option agreement (an agreement entered into by all shareholders of a private limited company, under which each shareholder grants to the other shareholders put and call options over his shares, which are exercisable on death) is also normally written in trust for the benefit of partners or share-holding directors when setting up a shareholder protection policy.
By writing the policy in trust, the proceeds from a policy pay-out are made to the trustees and not to the shareholder/partner. It is therefore possible that the premiums may fall within inheritance tax exemptions and therefore reduce the inheritance tax liability that the deceased’s estate may face on death.
By having this policy in place, a family business can be safe in the knowledge that it will have the liquid funds necessary to facilitate its smooth continuity and to also pay a fair price for the deceased’s shares in the business.
Our Private Client team will advise owner-managers of family businesses and significant shareholders in connection with succession planning and ensuring that not only will their dependants have sufficient financial provision, but also their business colleagues, in the event of death or terminal illness.
If you are affected by similar issues or would like to have a related discussion in confidence, please call me Nicholas Barlow Partner and Head of the Private Client team on 020 7692 7561 or Luke Jenkins Solicitor and a member of the Private Client team on 020 7631 4141 or email firstname.lastname@example.org email@example.com
The above is accurate as at 14 September 2021. The information above may be subject to change during these ever-changing times.
The content of this note should not be considered legal advice and each matter should be considered on a case-by-case basis.