John is the founder of a successful start-up, which he spent his entire life developing. His business drew the support of a number of investors, who became minority shareholders in his private limited company. Unfortunately, John fell ill and passed on, leaving his widow Jane as the administrator of his estate and assets.

Jane has no experience with her late husband’s business and wishes to sell the shares belonging to John. The investors do not have enough funds or desire to buy over the shares. On the other hand, since the company is a private limited company, Jane is unable to sell the shares on the open market. The business of the company suffers badly as a result.

The above story is just one example of the many common problems that small to medium enterprises (SMEs) face.

Most owners of SMEs are often busy running their businesses and do not have time to worry about trust and estate planning. However, this can create difficulties in the future, particularly because of the unpredictability of life and circumstances.

With a small amount of careful planning on trust and estate matters, many of these difficulties can be avoided.

From our experience working with clients, here are some effective ways to protect your business and your family:

1. Keyman insurance policies

In a situation where a key person dies, becomes disabled or retires, the business may have a sudden cashflow problem without the income brought in by that person, and may not be able to pay the monies to the key person’s family members and dependents.

Keyman insurance policies provide insurance against the loss of key personnel in an organisation or company. These may include a director, chief executive officer or key employee. The money is normally paid to the business upon the loss of the key personnel under such a policy.

These can be further structured in ways to maximise tax efficiency, and better allow the business to carry on smoothly without being suddenly stuck with numerous liabilities when the key person is lost.

Premiums from keyman insurance policies can be paid from the company funds. Furthermore, the protection of such policies can be maximised by having the partners within the company to hold the policy in trust for one another, which we will elaborate upon next.

2. Trust agreements between partners

A trust is a legal instrument where one person (the “trustee”) holds and uses property for the benefit of another person (the “beneficiary”). A trustee must act in good faith for the benefit of the beneficiaries. Where there are more than two partners involved, the most efficient method of organising a buy and sell arrangement is for all the partners to transfer the policies to a trustee to hold on trust for the partners. The trustee can be any one of the partners, or the partner’s solicitor or accountant or some other person considered suitable to be a trustee.

A typical Trust agreement of this nature, for example, would make provision for the use of death claim proceeds to finance the buying and selling of a partner’s share in the event of death. The trustee would be obliged to use the insurance payouts to pay the deceased partner’s personal representative for the price of the shares.

On the other hand, a typical agreement also provides for situations if the partner becomes disabled or retires, so that the proceeds or the policies are appropriately transferred in these circumstances.

You may consider fixing the price of the shares that you and other partners consider to be fair, or to put in place a particular mode of calculating the value of the shares.

These would effectively provide for the needs of the key personnel’s family if anything happens to him or her, while allowing the business to continue effectively.

3. Insurance Trust

An insurance trust is set up with a life insurance policy as the asset. The person who is entitled to the proceeds of the policy sets up the Trust so that, in the event of death, trustees hold the money payable under the policy.

The trustees may be subject to various duties, for example, to use the money to support the education of the deceased person’s children, or to pay the money towards various charitable causes. It is also possible to direct the trustees to invest some or all of the money, and then use the proceeds for the purposes laid down under the Trust.

4. Wills: hampering or helping the business?

Preparing a will is always advisable for anyone who is concerned about Trust and estate planning, even if you are not an SME business owner. However, if shares of a private limited company are covered by a Will, this may potentially hamper the running of a business if one is not careful.

This may happen, for example, if the Will requires the shares to be distributed to a majority shareholder’s children, and the children may be unwilling to sell the shares or have different views about the way the company should be run. These may lead to disputes with the existing shareholders and cause a deadlock in the business, affecting everyone negatively in the long run.

On the other hand, with careful planning, a Will could achieve a much better result, by clearly specifying how the shares should be distributed or handled in the event of death.

If you are an SME business owner, you may wish to consult a lawyer and consider how best you should arrange your affairs to better protect your family and business. SME business owners may wish to include various protections for their business in their Wills, such as stating how the payouts under insurance policies should be distributed.

It is often advisable to use more than one of these tools in order to ensure the continuity and sustainability of your business, to protect the interests of yourself and your loved ones both today and in the future.

As no two businesses are the same, you should obtain comprehensive legal advice to consider how your specific needs may be best protected.

This article was first published in our newsletter, The Custodian Issue 18 on July, 2021. Click here to access our latest newsletter.