Shareholder Protection Insurance – Why a Shareholders Agreement May Not be Enough

shareholder agreement

Losing a key shareholder to illness or injury will never be a pleasant experience, especially in those early days when a business is just getting started. Not only will you be losing an important member of your team, possibly a friend as well, but from a business perspective, such a loss can lead to significant turmoil. 

While many business owners will believe that their shareholder agreement is enough to cover them for such incidents, there are a number of limitations to be aware of.

What is a shareholder agreement?

First, a quick rundown of what a shareholder agreement actually consists of. A shareholder agreement is a common, legally-binding document that clearly lays out the professional responsibilities of all of the shareholders in a given company.

These kinds of documents are typically written up to minimise any potential for ambiguity when it comes to the running of a business. Shareholder agreements will often contain clear guidelines on how decisions are to be made, how disputes should be resolved, and how assets will be transferred in the case that a shareholder decides to leave the business.

No two shareholder agreements will be the same – they should each be written up with a specific business in mind, and as a result, it’s difficult to make sweeping statements about what protections they may provide. However, while they’re incredibly useful for clearly defining roles and processes, they’re not designed to provide financial protection for businesses in the case that a shareholder is no longer around to take care of their duties.

What are the main limitations of shareholder agreements?

The main limitations of shareholder agreements are that they provide no financial protections – this is not really a design flaw, they’re just not designed to take the place of insurance policies. This means that in the case that a shareholder were to die or become critically ill, a number of financial difficulties could likely arise.

For example, in such an instance it’s likely that their shares would be bequeathed to family members, placing the shares and any voting rights attached to those shares in new hands. 

Whilst a shareholder agreement may have various clauses that give the remaining  shareholders first-refusal to buy any shares which are made available for sale before they can be offered to any third party, the new owners may not want to sell or believe that the shares are worth far more money than they actually are. It’s possible that in this scenario the shares may even give the new owners a legal right to get involved in important decisions or get involved in the day-to-day running of the business which could be particularly undesirable. 

However, even if the shareholder agreement is extremely well drafted and regularly amended over time, it can not simply magic-up what could be a substantial amount of money to ensure the company’s control stays with the remaining shareholders. 

What is shareholder protection insurance?

There are protections available to businesses against these kinds of issues – notably in the form of shareholder protection insurance. For those unaware of what that is, in brief, shareholder protection insurance is a kind of insurance that aims to provide extensive financial protection in the event that a shareholder becomes critically ill or passes away. 

These insurance policies can be taken out by a single partner or by a group of partners, who want to ensure that their financial interests in the business are protected against such an unexpected (but at the same time highly possible) event.

Why would shareholder protection insurance payout?

The main purpose of a shareholder protection insurance policy is to provide a lump sum, to enable the remaining shareholders to buy the shares of an ill or deceased shareholder. The amount set in the premium can either be enough to cover the entire amount, or enough to at least ease the financial burden of having to buy what will likely be a significant number of shares.

Why would a shareholder protection insurance policy be useful?

The implications of a company being forced to buy out a shareholder who can no longer maintain their shares or financial interests in the company can be incredibly dire. If the remaining partners in the business were simply unable or refused to pay the necessary amount for the shares, then it’s possible that they’ll be sold to an outside party, leading to a decrease in the amount of control the remaining partners have over the business. 

It’s also possible that any remaining partners will be essentially forced to take out loans to pay for the remaining shares and assets held by the shareholder in question, which could be a far from optimal position to be forced into financially. Thankfully, shareholder protection insurance can help to limit the probability of either of these scenarios from running their course.

Would I pay for the premium or would it go through my business?

It’s typically better if the insurance premium is paid for through your business. Aside from the obvious fact that shareholder protection insurance is a business expense, paying for it through your business will also likely result in tax benefits that you wouldn’t be able to receive if you paid for it in a personal capacity.

On the topic of tax, you may be wondering if the payout would be liable for capital gains tax – the simple answer is probably not. As the premium would be unlikely to account for a rise in share value, the shareholders would not be standing to gain through buying out the shareholder. However, it will be important to consult with a tax lawyer or accountant to ensure that this applies to your case as well.

Your business isn’t just some abstract investment – how well it does has a direct impact on your well-being and your ability to look after any of your dependents. As a result, you clearly need more than the very limited protections afforded by a shareholder agreement – that higher level of protection can be achieved through the use of shareholder protection insurance. With safeguards like this in place, you can focus on your business and the well-being of your shareholders, even when things get tough, without having to worry about the impact that their ill health may have on your business.

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