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Shareholder Protection – Are you covered?

A close friend is the managing director of a communications company in Bristol. Tragically one of his fellow directors was diagnosed with cancer last year and died leaving a wife and young family. They didn’t have shareholder protection in place, but there was never a question, in his mind, about doing the right thing and purchasing the shares from his business partner’s wife. Fortunately, the business was in the position to do this from cash reserves; not every business could. Could yours?

What is shareholder protection?

Shareholder protection is a form of life assurance to ensure the smooth sale of shares, from the estate of a deceased shareholder back to the business. Typically, it would be set up on the “life of another”. That means the business takes out and owns a life assurance policy on the life of the shareholder.

How does it work?

Arguably, shareholder protection is one of the more complex areas of protection, not the life assurance itself. However, there are several factors that need to be taken into account when setting up a policy, e.g. the value of the shareholding, the term of the cover and whether the business value is expected to increase significantly over that period. Once those decisions have been made, a policy can be set up, which would pay out a tax-free lump sum to the business, enabling them to purchase the shares. Life assurance is often cheaper than most people imagine; over 10 years, £500,000 worth of cover, for a healthy 40-year-old woman, costs approximately £30 per month.

What is a cross option agreement?

One of the dangers of any major shareholder dying is what happens to the shares. It’s unlikely the business is going to want them sold to the highest bidder as they could end up in the hands of a competitor, they also might not want the beneficiaries of the deceased’s estate to keep them and have an input into how the business is run. That works both ways though, what if the business decided to play hardball and refuse to purchase the shares, for SMEs they probably have very little value elsewhere.

One of the dangers of any major shareholder dying is what happens to the shares. It’s unlikely the business is going to want them sold to the highest bidder as they could end up in the hands of a competitor, they also might not want the beneficiaries of the deceased’s estate to keep them and have an input into how the business is run. That works both ways though, what if the business decided to play hardball and refuse to purchase the shares, for SMEs they probably have very little value elsewhere.

How do I calculate the value of the business?

Valuing an unquoted company is difficult. Key professionals, principally the company accountants, should determine the most appropriate valuation method to use, after reviewing the articles of association to highlight any restrictions on the transfer of shares.

The size of the shareholding itself will be a factor, with a minority holding being less valuable than a majority holding. The shareholders may, however, decide to disregard any discount for a minority shareholding and instead value each shareholder’s interest as a simple proportion of the total value.

There are three commonly used ways to value an unquoted company:

  • Multiple of maintainable profits

A maintainable profit figure is reached by reviewing the trend of past and current performance, and considering projections of future profits. Any abnormal or non-recurring items will be excluded. This figure is then multiplied by a price/earnings ratio to arrive at a capitalised earnings figure.

  • Dividend yield

This method involves applying the level of yield a buyer might require from their investment to the actual dividend produced. This will then give a capitalised value, or the price per share they might be willing to pay. This basis tends to be only used for minority shareholdings.

  • Net assets

Net assets shown on a company’s balance sheet are not necessarily a helpful guide to valuing the shares unless the company is, for example, a property investment company.

4 Financial Planning

We offer a free protection review service for individuals and businesses. If you would like to understand if you have enough, or even too much cover, you can book an initial consultation using this link.

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