The sudden loss of a key shareholder can disrupt a company, but shareholder protection will minimise this interruption to the business.
Shareholder protection insurance pays your business a lump sum if a shareholder dies or is diagnosed with a critical illness. It provides the capital to help your company purchase the deceased or critically ill person’s share of the business and avoid potential disruption to the services you offer.
If a shareholder dies, then the shares are transferred to their family. However, the family may not want to be involved with the business, so the insurance policy helps to provide funding. The insurance policy would provide the fund to buy the shares from the family.
Is there a need for shareholder protection?
If shareholders are in any doubt, a review of the company’s articles of association will highlight the need for shareholder protection.
Most companies will have articles of association in place. The articles of association set out the rules for the running of the company’s internal affairs. So it deals with issues like transferring and selling shares.
Shareholder protection allows funds to be available when they are needed, on the death and/or critical illness of a shareholder. The sudden loss of a key shareholder can disrupt a company, but shareholder protection will help to minimise this interruption to the business. The shareholder or the shareholder’s family will quickly receive the true worth of their shares.
What is a Cross Option Agreement?
A Cross Option Agreement helps overcome the potential problems of the family owning the shares and how a business can use the insurance to buy them back.
When setting up this type of policy, the business could (or should) complete a cross option agreement, which will provide clear instructions on what must happen to the shares upon death / critical illness.
Cross Option Agreement
Remaining shareholders have an option to buy the shares, the deceased shareholder’s family have a matching option to sell to the remaining shareholders, no obligation until one of the exercises their option, the cross option agreement provides clear legal instruction on what happens.
A company is encouraged to seek independent legal and tax advice before entering into a cross option agreement.
What does Articles of Association mean?
In addition to a cross option agreement, the business’ Articles of Association should also be reviewed. These set out the rules of how the business runs, which can include the transfer of shares (not just in the event of critical illness or death).
The Articles of Association must not contradict the cross option agreement as this can provide delays and difficulties. In many cases, if the two contradict, the cross option agreement prevails.
What are the benefits with Shareholder Protection?
– Cross Option Agreement and Articles of Association provide clear guidance.
– The family have the option to sell the shares
– The business has the option to buy the shares
– It provides the mechanism for the business to remain in the ‘right hands’
Ultimately, shareholder protection insurance provides peace of mind to all parties in the event of a shareholder’s death. For the business, it provides reassurance that the finance is there to provide capital to purchase shares and help to at least reduce some of the disruption within the business.
