How to Set Up Relevant Life Insurance
Shareholder protection insurance offers a level of protection and reassurance to a business if a shareholder becomes critically ill or dies.
A shareholder protection arrangement provides a lump sum to the surviving shareholders that allows them to purchase remaining shares from the deceased or ill shareholder’s family or chosen beneficiaries.
For the business, it ensures that any shares remain with the company while reducing the financial turmoil caused by such a tragic situation.
For the deceased’s family, it provides some reassurance that they’ll receive fair value for the shares following a critical illness.
Within the umbrella of shareholder protection, there are some agreements that can be written in, which help lay out how and when shares will be purchased following a shareholder’s death.
What is a cross-option agreement for shareholder protection?
A cross-option agreement can be written into the shareholder protection insurance agreement. It sets out the options available to each party regarding their shares if one shareholder becomes critically ill or dies. Cross-option agreements are drawn up by a solicitor, not by a financial advisor.
There are two main types of option agreements:
Single option agreement
This type of agreement states that if a shareholder or business owner dies and can no longer continue in the business, they have the option to sell their shares and the other shareholders in the business have to buy them.
Double option agreement
In this scenario, the family or estate of a deceased shareholder can force the sale of shares back into the business. The agreement will determine how those shares will be distributed to the surviving business owners and shareholders and who will pay what amount to buy them.
Each option ensures that the outgoing shares are returned to the business with minimal disruption by ensuring that each party complies with the agreement.
For example, with a cross-option agreement in place, a deceased shareholder’s family would be forced to sell the shares back to the remaining shareholders, even if they wanted to retain control of them.
How do we write a cross-option agreement?
The options for a cross-option agreement are covered in the shareholder protection agreements or insurance taken out by the shareholders.
Alternatively, they can be written into the articles of association when the company is established if you don’t immediately take out shareholder protection insurance.
The cross-option agreement would state clearly what options each party is agreeing to regarding the sale and redistribution of shares, including the percentage of new shares each remaining shareholder will be responsible for.
No matter when you take out shareholder protection with this kind of agreement, it is highly recommended that it be reviewed on a regular basis.
This is because the value of the deceased shareholder’s shares could change over time based on the success of the company.
It will also help to understand if individual shareholders, or the business, need to adjust the level of cover they have under the shareholder protection insurance.
You should also write your shareholder protection insurance and corresponding agreements into a business trust. This will help to reduce the tax liabilities you could face in the event of a claim.
How does a cross-option agreement impact business relief?
Unlike some other agreements, cross-option agreements require that Business Property Relief for Inheritance Tax be held over the value of each shareholding.
It’s best to seek advice on drafting your cross-option agreement so you don’t lose Business Property Relief in the event of a sale of shares after a death or illness.
Is it worth signing a cross-option agreement?
Nobody wants to think about a time when they have to deal with the shares of a deceased or critically ill shareholder, but the reality is that it can happen.
If a critical or terminal illness occurs within your business, you must have protection in place to ensure the smooth transition of shares back to the company. This helps protect the jobs and livelihoods of the people working for you.
It can also provide peace of mind to a shareholder’s family that they’ll receive guaranteed money for shares in the event of a tragedy.
These agreements can be simply written into a shareholder agreement when death or critical illness insurance is taken out.
Having an agreement and insurance in place together ensures a smooth transition of shares, along with a guarantee that the necessary funds will be available.
Without insurance – if an agreement is just written into the articles of association, for example – remaining shareholders could find themselves in a position of being forced to purchase shares, without the funds available.
This obviously would put huge financial pressure on the business and could put its long-term future in jeopardy.
It’s also worth keeping in mind that cross-option agreements don’t represent a legally binding sale contract on their own.
They’re reliant on either party acting on their desire to buy or sell shares.
For example, if one shareholder dies, either their estate or the remaining owners and shareholders will have to actively start proceedings over the sale of the shares for a cross-option agreement to take effect.
Cross-option agreements and critical illness
A cross-option agreement can allow a shareholder who becomes critically ill to force the sale of their shares to remaining shareholders if they’re unable to continue in the business.
It can’t, however, be a force that forces shareholders to sell if the remaining shareholders want to buy them out due to an illness.
However, if a shareholder becomes critically ill, sells their shares in the business and then recovers and wants to return to the company, they won’t be able to take out critical illness cover again.
Using cross-option agreements to provide peace of mind
Ultimately, like shareholder protection insurance, a cross option agreement provides peace of mind to remaining shareholders, along with family or estates, over what will happen to any outgoing shares should a member become ill or die.
It provides reassurance to the remaining shareholders that they’ll remain in control over their company and can facilitate the smooth return of shares back into the company.
For a deceased shareholder’s family or estate, it ensures they are guaranteed a fair market price for any shares they sell and reduces the administration of returning those shares to the business.
It’s important to get professional help when drawing up your shareholder protection and any option agreements to avoid unnecessary confusion or conflicts.
At Rigby Financial, we’ve dealt with hundreds of businesses looking to protect themselves and their finances from any eventuality, no matter how unwanted or tragic they may be. Get in touch with one of our professional advisors today. We’ll be happy to discuss the options available to you and your business. Call 01744 886077 now.
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