Business protection booklet

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Business Protection/Continuity Planning …

Business Protection/Continuity Planning
Vital information for business owners and 3rd Party investors, on recognising and then mitigating the impact of human health risks to their business.

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  • 1. Business ProtectionRisks and solutions for business ownersand investors
  • 2. The risksWhat would happen in the case of an unexpected and dramatic event such as the death ofone of the owners or directors? Who would shares be transferred to in the case of death? How much control would be lost? What happens to the business in the case of critical illness? How would the value of the business (and therefore the investor’s asset) be affected? What action would dependents of the owners take?Should this happen, is your business protected?It is common for directors to focus on growing thebusiness, staying competitive and dealing with economic In a company with four partners orrisks. Many, however, do not consider the likelihood of directors with an average age of 35,unexpected and dramatic personal circumstances and there is nearly a 50% chance that onehow these might impact on the business – and indeed will die before the age of 65.their families. These risks are real and cannot be ignored. Source: see table in reference notesSome solutionsAutomatic Accrual AgreementsA life insurance policy is established for family or the estate. This is used to compensate thebeneficiaries of the deceased while the business interests are transferred to the otherbusiness owners. (Page 5)Cross-option AgreementsThis type of agreement ensures that the surviving shareholders have the option to buy thedeceseased’s share of the business. The widow(er) has the option to sell. (Page 6)Buy/Sell AgreementUsing a Buy/Sell agreement, the business owners all agree that on the death of a businessowner, the deceaseds estate beneficiaries will sell the business interests to the remainingbusiness owner(s). (Page 7)Double Option AgreementThe surviving shareholders can either purchase the deceased’s shares, or liquidate thecompany and pay a share of the total proceeds to the widow(er). (Page 8) 1
  • 3. Shareholder ProtectionExecutive cover for private limited companiesA private limited company is owned by shareholders and run by directors. Theseshareholders and directors could be the same people, especially in the case of family andsmall businesses.On the death of a shareholder the standard Articles of Association will follow the rules ofThe Companies Act 2006, specifically Table A of the Act. This states that the shares of thecompany form part of the deceased’s estate. "Welcome to the website of Bloggs, Smith and Jones, Sons, Daughters, Parents, Grandparents, Spouses, Uncles, Aunts, Cousins and Second Cousins Limited." Has your business got the succession arrangements in place that would avoid such a scenario?The other shareholders will ideally want to keep control of the deceased shareholdersshares. But the widow can technically sell them to anyone, even a competitor. If the sharesare fully paid-up, then the new holding must be accepted by the surviving shareholder(s).If the purchaser is a minority shareholder, there are measures within the Act that ensurethey are not mistreated by the other shareholder(s). Compensation or restitution can besought through the courts. The situation can become very complex and stressful for allparties.To avoid other people getting hold of the shares and being in control of part of thecompany, and ensure that the widow is properly compensated, a Shareholder Agreementand Shareholder Protection plan is essential.A Shareholder Protection plan is essentially an agreement detailing how the shareholdingshould be treated on death or serious illness of a shareholder, coupled with a life assurancecontract to facilitate the purchase of the shares by the remaining shareholder(s). Thereshould also be an agreed basis for valuing that share in the case of a dispute.It is necessary for each shareholder to take out cover on their own lives, for the benefit ofthe remaining shareholder(s). 2
  • 4. Executive Cover for PartnershipsA partnership is made up of two or more people who work together in business. Becauseeach partner owns a share of the partnership, they are entitled to a share of any profits. It isalso usual that these partners will be self-employed. If there is no formal agreement, on thedeath of a partner, the partnership will automatically be dissolved.i Even if ownership is split between the partners in differing amounts (for example 60%/20%/10%/10%), on death of a partner, the law sees them all as EQUAL!If one partner died without a current partnership agreement, the Partnership Act 1890states that all holdings were equal.Additionally, the surviving partner may want to take over the deceased partners share sothat they can continue to run the business without the complications of dealing with newparties.Further the deceased partner’s share of the business becomes a debt owed to their estate ifit can not be paid-out immediately. This debt must be settled before any profits are sharedamong the surviving partners. So they are forced to create more revenue with fewer people.In short, a Partnership Protection plan must be in place.Partnership Protection is essentially an agreement detailing the respective ownershipproportions of the partners, and how these would transfer on the death or serious illness ofone of them. This would be coupled to a life assurance policy that will pay out to theremaining partner(s). This will enable them to purchase the deceased partners share fromthe estate. The policy is taken out for the value of the share and is put in trust for the otherpartner(s).This is beneficial for the partnership and the family of the deceased - the partnership retainsthe deceased partners share and the family is paid for them.There should also be an agreed basis for valuing that share in the case of a dispute. 3
  • 5. Critical Illness Risks The average age for developing a critical illness? Forty three years old. A 25 year old non-smoking male has a 24% chance of developing a critical illness before he is 65. If he were a smoker the chance rises to 49%. Source: The National Institute of Critical IllnessesCritical illnesses such as a heart attack or the development of cancer can have an enormousimpact on the company, the person affected, and their family.Should a shareholder or partner suffer from a critical illness, they may not be able or willingto work at all or at the same level.  How would the company deal with a director who could no longer perform?  How might the director provide for himself and his family in such a situation?  Would the company expect the director to sell their shares?  Would the director expect them to purchase the shares at a certain value?The answers to these questions are of crucial importance.It could be a disastrous error indeed for both parties just assume that the other would act asthey expect. Drafting a written agreement while all is well, is essential.The average age for developing a critical illness? Forty three years old. Worldwide cases of cancer are likely to rise by nearly 75 percent by 2030. In 2008 there were 12.7 million new cases of cancer, which would rise to 22.2 million by 2030. Study by Dr Freddie Bray, The Lancet Oncology, May 2012. 4
  • 6. Third Party funding Business Protection can help! Taking steps to formulate a business protection strategy should greatly enhance the appeal of an SME to third-party investors.Investing in the small to medium size enterprises (SMEs) can be a considerable risk as oftenthe SME has few physical assets to match the investment.Essentially the investor is investing in a person, their idea and ability.In other words, intangible assets of the firm.The investor must therefore have great faith in the business model and the capabilities ofthe key people within the firm. Should one of these key people pass away or becomeseriously ill, the value of the firm (and therefore the value of the investment) fallsconsiderably and may be wiped out completely.  If the key entrepreneur passes away, could an investor realise their investment?  If a key person suffers a serious illness and the company’s value falls, could the investor be compensated, or would they simply have to accept the loss?Business protection provision, in the form of a written agreement and corresponding lifeassurance contracts, can therefore provide considerable comfort and reassurance to suchinvestors.Therefore such a plan offers an additional reason for the investor to choose the ventureover its competitors. 5
  • 7. Automatic Accrual AgreementA life insurance policy is established for family or the estate, equivalent to the value of theinterest in the business. This is used to compensate the beneficiaries for loss of the businessinterests on death. There is an agreement that the business interests are bequeathed to thesurviving business owners only.What happens?  Each business owner sets up a life insurance policy, possibly in trust, for their family or beneficiaries  An automatic accrual agreement is also set up at the same time for the business assets to transfer to surviving business owners  On death, the life insurance proceeds are paid to the beneficiaries and the business assets transfer to the surviving business ownersIn the event of death, the business owners share automatically goes to the survivingbusiness owners without going to the estate. For Inheritance Tax purposes the estate istreated as receiving the cash, unless the policies are in trust, and not the share of thebusiness. This may mean that Inheritance Tax may be payable.This is an absolute agreement; the beneficiaries of the estate cannot prevent the survivingbusiness owners receiving the interest in the business or reject the life insuranceproceeds. Shareholder A dies Life Assurance Policy Shareholding Cash Shares Widow Surviving shareholdersIn this example the widow never holds the shares and must accept the life assuranceproceeds in lieu of shares. The shares automatically pass to the surviving shareholders. 6
  • 8. Cross-option agreementThis type of agreement ensures that the surviving shareholders have the option to buy thedeceseased’s share of the business.The beneficiaries also have the option to sell the shares to the surviving shareholders.  If either party exercises their option, the other party is bound to comply.The value of the company is based on the audited accounts so the Life Company can acceptthe Sum Assured calculation. Shareholder A dies Shareholding Life Assurance Policy Shares Cash Cash Widow Surviving shareholders Shares On demand but NOT automaticallyIn this example the widow holds the shares and has the option to sell the shares to theremaining shareholders. The surviving shareholders have the option to demand the sharefrom the widow. Should either option be exercised, the other party must comply. 7
  • 9. Buy and Sell AgreementBuys and Sell Agreements use a life insurance policy with a special agreement for thebusiness owners to buy the business interests from the family.What happens?  Each business owner sets up a life insurance policy in trust for the other business owners  A cross-option agreement is also set up at the same time  On death, the life insurance proceeds are paid to and used by the remaining business owners to buy the interest in the business from the deceaseds estate.Using a Buy/Sell Agreement, the business owners all agree that on the death of a businessowner, the deceaseds estate beneficiaries will sell the business interests to the remainingbusiness owner(s).This is an absolute agreement; the beneficiaries of the estate cannot reject the survivingbusiness owners buying the business interest. Shareholder A dies Shareholding Life Assurance Policy Shares Cash Cash Widow Surviving shareholders Shares Automatic transferThis is similar to automatic accrual except here the widow holds the shares. On death theshares must be sold to surviving shareholders at their current value. This may be considereda safer option for the widow than the accrual method, where she assumes that the lifecover sum assured still reflects an accurate valuation.UK nationals should also read the additional notes in the reference section at the end. 8
  • 10. Double Option AgreementUsing a life insurance policy with a special agreement for the business owners to buy thebusiness interests from the family or decide to cease trading and liquidate the assets.What happens?  Each business owner sets up a Life insurance policy in trust for the other business owners  A double option agreement is also set up at the same time  On death either: - The surviving partner(s) purchase the shares from the deceased’s estate, using the life policy proceeds. - Alternatively the surviving partner(s) liquidate the company and pay the estate their share of the proceeds plus their share of the life assurance policy.The Agreement that allows the business interest to change hands:This type of business owner agreement allows the remaining business owners to buy thedeceaseds share of the business from the estate as an option and business property relieffor inheritance tax is still retained.This is an option agreement; there is a specified time during which the remaining partnerscan buy the share, and during this time the estate has a duty not to sell it to anyone else.The beneficiaries of the estate can reject the surviving business owners approach to buy ifthey do not act within a specified timescale. Shareholder A dies Shareholding Life Assurance Policy Shares Liquidation Cash Cash Widow Surviving shareholders Shares Option A Option B (liquidation) 9
  • 11. Keyman CoverOf course it may well be the case that a business has a crucial employee – someone that isdirectly responsible for a vital part of the business and considerable income generation.Without this person, the business may cease to function as well (or even at all) and profitswould be greatly impaired.It would be prudent to ensure that steps are taken to protect the business from the loss(permanent or temporary) of this person. Life assurance premiums for key employee policies can be 100% tax-deductible in Singapore.“The premiums incurred on ‘Keyman’ insurance will be tax deductible if this insurance is aninsurance against loss of profits to the company in the event of the death or physicaldisability of key personnel, subject to the condition that the capital sum insured does notexceed the annual profits of the company that are attributable to the relevant keypersonnel” Deloitte (Singapore) Corporate Tax note 2010Key person Coverage is typically calculated as follows:Key person’s total remuneration Expected total__________________________ X gross profits X recovery period (years)Total salary bill for the firmShould the key person’s remuneration be quite low in comparison to their contribution to profits,larger coverage can be negotiated.Bear in mind that a shareholder can also be a key person.It may be necessary to have two policies: - one to cover the cost of share purchase - one to cover lost profits caused by their death or disablement. 10
  • 12. References Chance that one Partner/Director will die before age of 65 NUMBER OF PARTNERS/DIRECTORS 2 3 4 5 10 AVERAGE AGE 35 28% 39% 49% 56% 81% 40 28% 39% 48% 56% 80% 45 27% 37% 46% 54% 79% 50 25% 35% 43% 51% 76% Source: Assured Lives mortality Table AM80Buy/Sell Agreement tax consideration for UK Domiciled persons:There could be a potential inheritance tax problem for the deceased persons estate. This is becausethe estate is deemed to have received cash, rather than a share of a business. This then means thatBusiness Property Relief, where there is no inheritance tax payable on death for the transfer ofbusiness assets, would not be available if the assets were subsequently transferred from the estateto the other business owners.Disclaimer:The legal measures and scenarios in this document are correct according to our understanding.Meyado is not authorised to advise on legal matters.Meyado does provide professional advice and execution on insurance matters.Therefore separate legal opinion and advice must be sought from authorised legal professionalsprior to enacting any change of policy or documentation.We would be happy to refer you to the excellent legal services firm with whom we work closely inthis area, should you so require.Neither this document nor any information contained herein shall be construed as an offer,invitation, advertisement, inducement, representation of any kind or form or any advice orrecommendation to buy or sell any financial products. Please contact us for a full financial needsanalysis.Meyado Private Wealth Management Singapore Pte Ltd150 Cecil Street, #15-02Singapore 069543Tel +65 6538 3583Fax +65 6538 3234Email: peterseligman@meyado.com.sgwww.meyado.com.sg 11