Business protection case study, questions and answers
Clive, Jake and Derek Cooper are triplets aged 42 and all in good health. They jointly own and work in a limited company called Cooper and Co Ltd, a firm of business consultants. They have been trading for five and a half years and work has grown steadily in that time.
4 years ago, the company took out a small business loan on a capital and interest repayment basis for £25,000 over 10 years to aid expansion and pay for necessary capital items. The company took out a decreasing term assurance on each life with combined critical illness cover to repay the loan immediately if either of these events occurred.
In 2014, the brothers were finding that they were so busy with actual consultancy work, that if they wanted to expand further, they would need to hire an experienced employee, Christine, to help with both business operational duties and market the company to obtain new business. At the same time they took on a trainee, Kevin, to assist with the more straightforward work and gradually build up experience to help with the ongoing major projects being undertaken.
Kevin is progressing steadily but Christine has become a real asset. She happily carries out her duties and promotes the company so successfully that she has recently been a major contributor towards the business gaining some excellent contracts. The brothers have realised her worth and have been able to take on two more trainee consultants and further administrative staff to enable Christine to concentrate on gaining further new business. They also realise the consequences to their organisation should anything unfortunate happen to Christine that would stop her from working. They require your advice on this point.
The brothers are also worried about the consequences to the business in the event of any of their deaths or long-term illness. As things currently stand, the remaining brothers would not be able to afford to purchase a deceased or retired (through critical illness) brother’s shareholding if such an event happened. In addition, the articles of association do not cover specifically what the remaining shareholders would do in these circumstances.
Last year, the company made net profits of £400,000. Having spoken to their accountants, the brothers have provided an estimate of £660,000 as the total value of their business. The three brothers have an equal third shareholding each in the business.
Questions
1. The brothers have discussed matters and wish to receive advice and recommendations on the following protection needs:
a. Cover in the event of Christine’s death or critical illness to protect business profits. Christine earns a salary of £30,000 and the total salary bill is £250,000. They estimate that it would take up to 3 years for the company to satisfactorily recover if the above event was to occur.
b. Cover to allow the remaining brothers’ to purchase the shareholding of any brother who dies or becomes critically ill between now and when they retire. Anticipated retirement age for each of them is 65. They are concerned that any arrangements they make are flexible and do not give rise to further liabilities to inheritance tax.
Outline how each need can be met and list the protection products and associated documentation that could be used.
2. Calculate the amount of cover required and term for each product listed in your answer to Question 1.
Answers
1.
a. In respect of Christine, the company could effect Key Person Term Assurance to cover loss of profits in the event of death or critical illness.
b. In respect of shareholder protection, each of the brothers could effect a level term assurance written in trust for the benefit of the remaining shareholders. The trust should be flexible to allow for any incoming or outgoing shareholders. The shareholders should establish a cross option agreement to give the either the deceased’s estate / retiring shareholder the option to sell or the surviving shareholders the option to buy the shares. A cross option agreement will not endanger Business Property Relief for IHT purposes.
2. Key Person Term Assurance will have a term of 3 years. Depending upon what is agreed, the amount of cover can either be a multiple of salary e.g. 5 times £30,000 = £150,000 or worked on the proportion of profits formula. Using This would be calculated as £30,000 (Key Person’s salary) / £250,000 (Total salary bill) x £400,000 (net profits) x 3 (No of years to find replacement) = £144,000
With regard to share purchase protection, each policy would have a term of 23 years (to retirement age). Cover for each policy should be £660,000 / 3 = £220,000