Financial planning

Risky Business – The business protection gap

In my experience business owners, especially in the early years, find themselves working in the business rather than on the business, which leaves them consumed with the day-to-day rather than attending to their long-term financial security. Gaps can appear, such as the shortfall in business protection.

The life cycle of a business may create personal and business risks for the owners. For example, let us go through this journey with Anita and Brad, two entrepreneurs who set up in business themselves some time ago.

Funny Bones Physiotherapy Ltd

Both Anita and Brad are aged 45 and held successful careers as physiotherapists. Anita had several positions with some of the leading private healthcare providers and Brad had a 20 year career with the NHS. Four years ago they branched out to set up their own practice.

It is not uncommon to see professionals embark on the entrepreneurial journey, setting up shop by themselves to capture the entirety of value in what they do. However, when they leave the employment of their respective organisation, they also leave the benefits of being employed, that is, pension provision, private healthcare and, of course, insurance, whether that be life insurance, critical illness and/or income protection.

Upon the switch from employee to employer/owner, the perspective of insurance often takes a different form, from benefit to cost. Management of costs is often a primary concern of business owners and the cost of insurance is something many dismiss.

Relevant Life cover offers a tax efficient opportunity to implement life cover for directors and employees alike, without the need to set up a group scheme.

The premiums are paid by the company and are usually considered tax deductible, so long as the company’s accountant and the local inspector of taxes are happy that the premiums are ‘wholly and exclusively for the purpose of trade’.

Why Relevant Life could be suitable for Anita and Brad?

The success of the business is imperative for Anita and her family, because the associated income services a large mortgage and she has limited pension savings. She also holds the view that the business is her pension, believing the sale proceeds of the business will provide for her and the family during retirement.

Relevant Life could tax efficiently cover the short-term tangible risk posed by the mortgage, as well as the long-term risk posed by the more intangible value of the business in the future.

In terms of Brad, he too has liabilities that the policy could cover. The use of a Relevant Life policy rather than a group scheme will ensure there is no impact on his lifetime allowance (LTA). His 20 years in the NHS has seen him accumulate a significant pension pot that is likely to breach the LTA. Unlike a group life scheme, the benefits in the event of death would not be tested against Brad’s LTA.

Moreover, as both individuals continue to accumulate wealth, IHT could become an issue. Funds paid out to beneficiaries from a relevant life policy are done so into trust, thus circumventing probate and IHT consideration. Therefore, the funds could be paid out to the beneficiaries and should not only be free from IHT but could provide much needed short-term liquidity to the beneficiaries.

Ownership and control – shareholder protection

Five years on, their business is going from strength to strength! With the growing success of the business comes added value of Anita’s and Brad’s respective shareholding. Now aged 50, they are looking to the future. Exit and succession planning are on the agenda.

The two main objectives for Anita and Brad are the integrity of the business and ensuring their respective beneficiaries are taken care of. That is, Anita and Brad have managed the business successfully for nine years and trust each other to take the reins if needed. However, neither of their respective spouses or children have been or are likely to be involved in the business, thus, they are keen for them to receive the fruits of their hard labour without necessarily having to inherit a going concern.

The risk here lies with the company not being able to buy the shares and being stuck with a majority shareholder with little or no interest or experience in running the company. Conversely, the beneficiary could be stuck with a shareholding that they have little or no interest or experience of and be unable to sell.

Shareholder protection is an insurance policy that can provide the company or remaining shareholders the funds to purchase the shares from the deceased estate, or if they become critically ill, while the beneficiaries would receive fair value based upon a set of agreed terms.

The addition of a cross option agreement places a legal obligation on the beneficiary to sell and the company or remaining shareholders to buy. Therefore, the wishes of both Anita and Brad could be secured without the fear of one or all parties disagreeing after the fact because it would have already been arranged.

The implementation of a policy of this nature should be done in conjunction with an updated Will and legal advice. This ensures that both family arrangements and Inheritance Tax (IHT) are considered in full.

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