First, a quick reminder of the example company I have used throughout these articles: Totley Printing. Of 1,000 shares in this company, Jeremy owns 500 (50 per cent), Marie 300 (30 per cent), Claire 150 (15 per cent) and John 50 (5 per cent).
If the share-purchase arrangement makes provision for the surviving shareholders to buy out a deceased’s holding, then Marie would have to ensure she has funds available of £300,000 should Jeremy die, Claire would have to ensure £150,000 was available to her at that time and John would have to ensure he had £50,000 available (see table). Marie would then own 60 per cent of the shares (600 out of 1,000), Claire would own 30 per cent (300) and John 10 per cent (100).
If, instead of the survivors buying Jeremy’s shares, the arrangement was for Totley Printing to buy them it is important to note that Jeremy’s beneficiaries would still receive £500,000 (as they would from the individual buyers).
Jeremy’s shares, having been bought by the company, are then cancelled, so only 500 shares remain in issue. Although, through this method, the survivors have a lower number of shares than would have been the case through the individual buyer strategy, they have exactly the same percentage shareholding either way. However, it must be noted that, for the company to buy the shares, a potentially unwelcome CGT problem may arise.
If the “company buyer” route is taken, funds for the purchase of a deceased’s shares must be made available by the company, not the individuals. This option is convenient in as much as changes in shareholdings before a death are easily or automatically accommodated.
Should Marie dispose of her shares to a new buyer, for example, there would be no need to make any different provision for the purchase of shares on Jeremy’s death – £500,000 would have been required by the company on his death before Marie’s sale of shares and the same amount is required after her sale. Had the arrangement been set up on an “individual buyer” basis then before the sale of her shares Marie would have had to ensure £300,000 was available for the purchase of Jeremy’s shares, whereas after the sale this is the new buyer’s responsibility.
In practice, either method can accommodate such changes in shareholding. However, there are vital implications for the way in which associated life assurance policies are effected as regards the recipient of a sum assured as, in these articles, I have not yet answered the likely problem with the solutions discussed – that few shareholders or companies will have enough capital readily available to purchase a deceased’s shares.
Take the example of a private company with a value of, say, £600,000 with three equal shareholding directors each taking salaries of around £70,000 a year.
On the death of one of the shareholders one would expect the survivors, either personally or through the company’s finances, to have to find £200,000 to buyout the deceased’s shares. How likely is it that £200,000 would be readily available in free capital or borrowing capacity without hurting the financial stability of the survivors? Indeed, in many companies, how likely is it that £200,000 would be readily available at all?
Even if an appropriate share-purchase arrangement is put in place, properly agreed and documented, it will prove useless if there is not enough funding in place to enable the shares to change hands at the pre-determined price.
In the majority of share purchase arrangements, therefore, life assurance policies form an integral part of the strategy. They aim to put the right money in the right hands at the right time. But what exactly do we mean by this phrase?
First, the right money simply means that the life insurance policy should usually be written for a sum assured equal to the amount of money that will be needed by surviving directors or the company to enable the buyout of a deceased shareholder’s shares at the predetermined price.
The sum assured may be lower than the buyout price f alternative part-funding can be anticipated, say, from the buyer’s own resources or from borrowing capacity. The computation of an appropriate ongoing sum assured will depend on the method of valuation of the shares, as I have discussed in previous articles.
The right hands means that the correct sum assured should go to whoever will need funds on the death of a shareholder. This will depend in part on whether the share-purchase arrangement has been established with the company or the surviving shareholders buying the shares.
If the company is to buy the shares, then the life insurance death benefits must be payable to the company, if the surviving share-holders are to buy the shares, then the death benefits should be paid to them.
More than simply relating to the identity of the recipient(s) of the death benefits, though, “the right hands” can also be taken to indicate a need to consider how the death benefits reach those recipients – primarily whether they are to be paid directly from the insurance company, or whether they receive the money through a trust into which the death benefit is initially paid.
Finally, the right time should ensure that the sum assured under the policy should be paid to the appropriate recipients on the death of a shareholder, as it is at this time that the surviving shareholders need funding to buy out the deceased’s holding.
Most often, the life insurance policies in a sharepurchase arrangement are written on an own-life, ownbenefit basis, meaning that the each shareholder effects a life insurance policy on his or her own life (and is therefore the life assured) for his or her own benefit (and is therefore also the assured).
Alternatively, these policies can be written as life of another. Under this method, each participant in the share-purchase arrangement is the life assured under a policy with the proposer(s) – who become the assured(s) when the policy comes into force – being the fellow participants in the arrangement. There is therefore no need for a trust or assignment as the payment of death benefit will be made by the life insurance company directly to the fellow shareholding participants as the owners of the policy.
This method, allowing little or no flexibility to change the identity or the respective shares of the policy owners, is not often used in share-purchase arrangements except where the company, rather than the individuals, is to buy the shares on the death of a shareholder and therefore the company is the proposer and subsequent owner of each policy.
That leaves us with only one remaining question to be answered in the concluding article in this series – who pays the premiums?