There are more small businesses in the UK today than ever before but far too many are failing to protect themselves against the two biggest risks they face, writes Tom Conner, director of financial advisors Drewberry.
Britain has become a nation of small business owners. At last count, there were almost 5.5m SMEs in the UK with an estimated turnover of £1.8tn per annum (getting on for half of all private sector turnover in this country).
But while we have a great tradition of creating vibrant new businesses in this country, our track record of protecting those enterprises still leaves a lot be desired.
There are two primary threats facing any small business. The first is the risk that its founder or another shareholding director dies, creating uncertainty as to its finances, its future ownership and, quite possibly, its continued existence.
The second is the risk that the company suffers the loss of a key member of staff for an extended period, which can also frequently lead to the premature demise of an otherwise healthy business.
Ironically, both problems can be resolved through relatively simple insurance cover that’s funded by your business but, true to form, most small business owners are too busy working for their companies to spend time working on them. If they did, the so-called “business protection gap” – the gulf between the value of the business assets owned by Britons and the value that’s insured – wouldn’t currently stand at an eye-watering £600bn.
First things first
The first problem, namely succession planning, can be addressed with what’s called shareholder protection insurance. Don’t make the mistake of thinking this is somehow for older people. It’s never too early to start thinking about succession issues.
Remember that having a decent shareholder protection arrangement in place is the only reliable way to ensure both the continuation of your business in its current form after you’ve gone and that the families of those who built the business (yours included) are adequately rewarded for all that hard work.
With no formal arrangement in place, when a shareholder dies, their shares will pass to their next of kin. But a “like-for-like” swap among family members isn’t likely to improve the position for a company that’s just lost one of its founding shareholders.
Meanwhile, most family members who inherit private company shares want nothing so much as to “move on” with a lump sum that fairly reflects the years of hard work it represents. For them, the worst thing that can happen is to be “frozen out” with a pile of shares they can’t sell and that the remaining shareholders have neither the means, nor the motive, to purchase.
In case of emergency…
A raft of shareholder protection policies provides both the means and the mechanism to enact a smooth, tax-efficient transfer of a director’s shares in the event of their death or ill health. It’s just a series of individual life, and possibly critical illness, policies on each shareholder, each of which is written in trust for their fellow shareholders.
However, there are quite a few hoops to jump through. This means it’s well worth engaging a business protection adviser who can help you over the main hurdles, the first of which is usually the valuation.
Insurers will require that your valuation of the business can be justified, which often means that the valuation is based on a “reasonable” EBITDA/profit multiple. For very early-stage businesses/startups some insurers may consider a revenue multiple instead.
You’ll also need to put a “cross-option agreement” in place (and a “single-option agreement” if your policies cover serious illness), which specifies that if the heirs wish to sell the shares, the business must buy, and vice versa. The wording is important here as if they lose what HMRC describes as their “commerciality” they risk being assessed for inheritance tax. You’ll also need to ensure that the premiums are “equalised” – something else your adviser can talk you through – or you risk falling foul of the same rule.
In a nutshell, a shareholder protection arrangement provides both the means and the mechanism for the shares of a deceased shareholder to be bought by the remaining shareholders from the deceased shareholders family. This ensures the existing shareholders retain complete control of the business and the family of the partner that passed away are financially compensated in full for those shares.
Who holds the keys to your business?
The other great threat facing every smaller company is that of losing key members of staff to long-term illness or death. For many, it can be like losing a wheel on the motorway. Companies that employ less than ten people are especially vulnerable to such losses and, indeed, a lack of “keyman insurance” cover can often put off new investors and inhibit future growth.
By contrast, a good package of keyman cover can protect an investor’s capital and their expected return, it can also cover company borrowing as well as risks such as the loss of key clients, contract failure, loss of new business, additional recruitment and training costs, temporary staffing costs and even the startup costs for a new business.
But finding the right level of cover, for the right people, can be more art than science. This makes finding an experienced adviser who can guide you through the process a must.
Keyman cover: agreeing terms
An advisor can help put worthwhile commercial values to the contributions made by different staff members. They can create a watertight application for insurers, assemble valuable business data, search the market for the best combination of premiums and policy terms and monitor a policy throughout its lifetime making sure that the benefits continue to rise in line with the company’s profits.
Meanwhile, for what, in most cases, will be just a few hundred pounds a month in premiums, the cover that results could one day be the difference between whether a company, and the families that it supports, sink or swim.
This article was written by Tom Conner, director of Drewberry. From offices in London and Brighton, Drewberry provides financial advice to clients across the UK on personal insurance, business protection, employee benefits, pensions and investments.
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