Financial protection

How to recover quickly and minimise the impact should the worst happen

Whether you’ve been in charge of a successful business for several years or have only recently started up your own enterprise, it’s important to understand the challenges and potential pitfalls and to think of ways of minimising their impact.

How much is a key employee worth to a business? And how would, or could, that business cope without them? Many private businesses rely on one key person. Financial protection is vital to allow your business to recover quickly and minimise the impact should the worst happen.

Key employees are vital to a business

Business protection helps to protect a business should a director, partner, member or key employee suffer a critical illness, become unable to work due to a disability or die prematurely. It helps to make things right when things go wrong. Key employees are vital to a business.
There are several different types of business structures in the UK, all governed by different rules that determine the business's legal status and how it is run. These rules include the amount of tax you pay, who is entitled to the profits, and who is liable for any debts run up by the business.

Type of business and its particular needs

Business protection is available for partnerships (including limited liability partnerships), shareholders, sole traders and key employees. It can also be used to ensure repayment of a business loan in the event of the death or critical illness of a partner, key person or sole trader. How the arrangement is set up will depend on the type of business and its particular needs.

Losing one or more of your key employees can cause disastrous problems. Sales may be lost. Credit can become more difficult to obtain. Profits may shrink. Momentum may be lost. Also, hiring and training a replacement will cost you time and money.

Experts at protecting businesses every step of the way

Most astute business owners insure physical assets from destruction. But when it comes to a business owner's most valuable assets – key employees – many forget to take the same precautions. Whatever type of operation you run, if successful, will grow and evolve over the years. If you’re just setting up your first business, the challenges you face may be very different from those you may encounter ten or twenty years later.

To help you understand more about these risks, consider these key areas:

Key person insurance

This is designed to compensate a business for the financial loss brought about by the death or critical illness of a key employee, such as a company director or other integral staff member. It can provide a valuable cash injection to the business to aid a potential loss of turnover and provide funds to replace the key person.

You cannot replace the loss of a key person, but you can protect against the financial burden such an event may cause. Without the right cover in place, you could also risk losing your business. Key person insurance can be utilised in several different ways – for example, to repay any loans taken out by the key person, to help recruit and fund the training costs for replacement staff, to meet the ongoing expenses while the level of sales recovers; or to facilitate payments for outside consultants or expert advice that may be required.

Businesses need to be insured, but covering the risk of losing a key employee is not legally required. Because of this, it’s easy for businesses to overlook this protection. But remember, your employees are your most valuable asset.

Shareholder and partnership protection

This provides an agreement between shareholding directors or partners in a business, supported by life assurance, to ensure that there are sufficient funds for the survivor to purchase the shares.

It is designed to ensure that the remaining partners or directors retain control of the business, but the value of the deceased’s interest in the business is passed to their chosen beneficiaries in the most tax-efficient manner possible.

The shares might pass to someone without knowledge or interest in your business. Or you may discover that you can’t afford to buy the shareholding. It’s even possible that the person to whom the shares are passed becomes a majority shareholder and is in a position to sell the company.

The shareholding directors or partners in a business enter into an agreement that does not create a legally binding obligation on either party to buy or sell the shares but rather gives both parties an option to buy or sell. For example, the survivor has the option to buy the shares of the deceased shareholder, and the executors of the deceased shareholder have the option to sell those shares.

In either case, the exercise of the option creates a binding contract; there is no binding contract beforehand. This type of agreement is generally called a ‘cross option’ agreement.

Cross option agreement

This is also known as the ‘double option’ or ‘put and call’ agreement. By taking out a cross-option agreement, you will determine what will happen to the shares in the business if one of the owners dies or becomes critically ill. This agreement mustn't be binding regarding the sale of the shares because this will prevent you from claiming relief from Inheritance Tax.

Other protection options available

There are various options to choose from, including life cover only, critical illness cover, or combined life cover and critical illness cover. You can select different levels of cover and terms depending on your specific requirements, and policies are available that pay out a regular income in the event of sickness.

Relevant life cover

A relevant life policy is an alternative way for an employer to set up life cover for a key employee tax-efficiently, without using a registered death in service group life scheme to benefit the employee’s dependents.

Calculating the level of cover required

The cover required is typically measured by reference to the key person’s contribution to the business's profits. This may be based on the following information: past profits and projections for the future; the effect that the loss of the key person would have on future profitability; the anticipated cost of recruiting and/or training a replacement; the expected recovery period, for example, the length of time before a replacement is effective; and the amount of any loan(s) that would be called in on the death of the key person.

The death or prolonged illness of a business partner, key employee or shareholder could put your business under considerable financial strain. No one can predict what will happen in the future, but you can ensure that you have the right protection to keep your business successful should the worst happen