I am a shareholder with two colleagues in a limited company. Recently, we have heard about a scheme that provides funds for the remaining shareholders to purchase shares on the death of another of the shareholders. Could you tell us more about this?
This type of arrangement is usually referred to as shareholder protection and you are correct in saying it is designed to provide a sum of money on the death of a shareholder so that the deceased's shares may be purchased from his or her estate by the remaining shareholders.
Such a scheme can, and I would suggest should, include a provision for payment to be made on sufferance of a serious illness. For simplicity, I shall refer only to death benefits in this reply.
A shareholder protection scheme consists, in essence, of a number of life insurance policies. However, the manner and framework within which they are established can be varied. The tax and legal implications are such that it is absolutely vital that the company's accountant and solicitor are fully involved. Double-option agreements (and single-option agreements if critical illness is included) will be required. These provide an option but not a legal obligation to buy or sell. This is important for tax purposes.
The following are some of the main items you will need to consider with your advisers before deciding on the exact structure of the scheme.
I would suggest that the value of the company should be calculated by your accountant or an independent valuer to ensure the sums assured are relevant. The company value and, therefore, sums assured must be kept under regular review to ensure they remain relative.
Where there is a large variation in the holdings, then one cannot simply say that each holding is pro rata to the total company value. Professional opinion would definitely be required.
What type of life policy will be used? A whole-life policy is the preferred option, given that there will often be no parameters set as to the age at which shares must be sold. However, this will also be the most expensive policy to effect and you may, therefore, also wish to consider the alternative of term insurance, which will provide cover only until a set date.
Who will effect the policies? This is a choice between the company and the individual shareholders. If the company takes out the policies, then, on the death of a shareholder, the company will buy back the shares before cancelling them and restructuring as required.
If you take out policies as individuals, you could choose either to take out a policy on your own life and place the benefits in trust for the remaining shareholders or, alternatively, each shareholder could effect a policy on the life of the other shareholders. The former is the most popular as this provides a greater deal of flexibility and means that changes can be made speedily to the scheme to reflect any changes in the shareholding.
Who will be paying the premiums? If the company pays the premiums, then this will be treated as an increase in salary and the individual will be taxed accordingly. If the individual pays the premiums, then this will be out of net income.
How will premiums be allocated? Each individual could be responsible for paying the premiums on their own life or the total premium could be shared equally between the shareholders. In cases where there is a wide variation in premiums, calculations could be made to arrive at proportionate amounts relative to how the individuals will benefit.
Alternatively, in cases where there is a big discrepancy in premiums due to variations in shareholdings, age or smoking habits, then this could provide a good reason for the company to effect the policies and pay the premiums.
This brings me to the final question, which is what do the company's articles permit? Do they allow the company to purchase the shares, cancel and restructure? If not, then amendments will have to be made. I hope you can see the importance of involving all your professional advisers.