Visit our sponsor.
In the smallest of businesses life and death are simple. The one man band earns while alive , and in death his family either thank him for the insurance, or are wise after the event.
Life is not so simple where there are Partners or Directors and the business is more of team effort.
Most people assume that , should they die, all will be well. The family will be looked after and everyone will muddle through. As assumptions go this is about as valid as assuming that just because a bride wears white she is a virgin. It may be true, but would you bet the family fortune on it? ( Which exactly what you are doing if this essay applies to your own situation ).
First the facts :-
Partnerships offer certain rights to widows, Limited Companies offer only shares.
In the event of a death in a Partnership it is fair to say that some maths will be done and an entitlement computed. However the actual payment may be much less than anticipated for many reasons, not least of which, even assuming good faith on all sides, could be cash flow.
In the case of a Company at first glance things are better. The widow has some shares. Unfortunately these may be worth little as they carry precious little power if a minority holding. Most working Directors get a salary, a bonus, and, from the shares, a dividend.
A shareholders only source of income is dividends. If the surviving Directors did not like the widow they could switch from dividends to salary/bonus thereby cutting her out of the loop. She has no right to a job with the company. Her only option is to either accept the very low offer that will be made for her shares, or hope for a later chance to play politics.
Even assuming the best of intentions there is always the cash flow question. A shareholding may be worth a lot of money, but the chance of that sum being to hand at short notice is low. Accepting an instalment basis is to be taking a risk on the future of a company with which you have no useful connection.
If the widow is a majority holder she still has problems if she cannot step into the deceased shoes. The company is usually the people, and in most small companies they can walk.
The good news is that when people think about it they normally realise two things :-
1) Any one of them might die and their family lose out.
2) To sort out the situation in advance is a good idea.
As usual you can only start from where you are and each Partnership and Company will be different, with different options. There are however some general points that can be considered.
1) How much is the business worth, and who gets what?
No need for any great computations and auditing. In most cases a discussion over lunch will produce an acceptable figure, and the split should be obvious.
For example a three director equal split business is worth £300,000. Each Director therefore wants his family to benefit to the tune of £100,000 if he dies, but if someone else dies he wants half of that directors shares.
The upshot is that on one hand each Director wants to maximise the value in case he dies, and minimise it should he be a buyer.
The overall effect is to produce a current fair price, but it is important to build in a review mechanism in case the business grows, ( or shrinks ).
2) How to structure the insurance policies.?
Once you know the size of the problem it will be dealt with by means of insurance policies, usually with each person paying their own costs, ( on the grounds that their families are the eventual beneficiaries ), although other systems can be devised to suit any particular need and budget.
There are tax implications to explore but in general the premiums will not be deducted for tax purposes, ( thereby preventing any policy proceeds being taxable), policies will be written under trust, and a formal agreement will be drawn up to ensure fair play.
Taking our example of three directors each with £100,000 policies the question arises as who benefits from the policy in the event of death. If the spouse then she gets the money and keeps the shares, which is not the desired outcome.
In fact the policy pays in trust to the other directors in equal shares, ( or as otherwise laid down in a more complex case ), while the spouse gets the equity.
So far there is no change on the original situation in which no arrangement had been made. The spouse has some worthless shares, though the other directors are richer and could pay for them, they are not obliged to do so. Hence the Formal Agreement.
The Formal Agreement could enforce the sale of shares for proceeds, but for various reasons it is more likely to be a Cross Option agreement. This means that the Spouse can Opt to demand that her shares be bought for the agreed amount, or that the Directors can Opt that she sell them, thereby ensuring that she gets the money and they get the equity.
The other advantage to using Trusts and Cross Option agreements is that the comings and goings of new owners, and alterations in relative holdings can easily be dealt with by altering the Trust and Option and not affecting the policies themselves. ( Think of the problems that might arise if you needed to rewrite the actual insurance policies and someone had had a heart attack recently ).
Does this matter? Well if four people aged 40 are in business together the odds are greater than 50% that one of them will die before retirement. Food for thought.