Key person and shareholder protection: two different business risks

Key person protection addresses a business's financial exposure to losing an important individual. Shareholder protection concerns the money and arrangements needed for an ownership transfer after a specified event. Both can involve life insurance, but the intended recipient and purpose of the proceeds are different.

A business owner should therefore begin with the problem to be funded rather than one overall figure called business cover. Operating continuity, ownership, business borrowing and family security may require separate analysis.

Identify what would happen operationally

Consider whose absence would affect revenue, customer relationships, technical delivery or the ability to fulfil contracts. The person with the largest shareholding is not necessarily the only person whose loss could cause substantial financial disruption.

Map the likely impact over time. Which activities stop immediately? Which can colleagues cover? How long could recruitment and training take? Distinguish lost revenue from lost profit and additional costs, so the same effect is not counted several times.

Legal & General's key person explanation describes an employer-owned arrangement with proceeds payable to the business for covered events. It is a provider description, not an independent recommendation or a statement that every policy has identical terms.

Build an operational funding illustration

Suppose a fictional business estimates £40,000 of recruitment and transition costs, plus an £8,000 monthly cash shortfall for six months after losing a particular employee. The identified exposure is £88,000 before other effects.

If £25,000 of cash has genuinely been allocated to that contingency, the remaining illustrative gap is £63,000. These figures are not a recommended sum assured. They show the assumptions an adviser and insurer would need to examine, including whether the estimates are supportable.

Do not subtract all business cash as though it were available for this purpose. Funds already needed for payroll, suppliers and tax cannot simultaneously be treated as a spare contingency reserve.

Identify the separate ownership question

After a shareholder's death, the remaining owners may want to buy the interest while the estate or family may want to realise its value. A commercial desire to complete a transaction does not itself establish the legal rights, price or available funding.

Legal & General's shareholder protection guide explains arrangements linking insurance with ownership agreements. The legal documents, company structure and policy ownership must work together; buying a policy alone does not resolve how shares change hands.

Ask a solicitor to review the company's articles, shareholder agreement and proposed options. Obtain tax advice on the specific structure. Generic wording downloaded from a provider should not be treated as confirmation that the arrangement suits the business.

Use an agreed valuation method

For illustration, a company valued at £1.2 million has two owners holding equal interests. A simple proportional value for each is £600,000. That arithmetic does not determine the correct legal or commercial valuation: rights, valuation provisions and the circumstances of a transaction can matter.

Agree how the relevant value will be established and reviewed. A policy based on an old estimate may provide too little funding after business growth, or more than is appropriate after a material change.

Also ask what happens if insurance proceeds and the required purchase price differ. The agreement should not depend on the two figures always matching exactly without a process for dealing with the gap.

Check who owns each policy and receives the money

Draw a short money-flow map for each proposed arrangement: premium payer, life insured, policy owner, claim recipient and intended use. If a trust or option agreement is involved, include its role and obtain the relevant advice.

For key person cover, proceeds intended for company cashflow are not automatically a payment to the employee's family. For shareholder protection, money intended to buy an interest is not automatically available to cover trading losses as well.

The same amount should not be promised to two jobs. If the business needs both continuity funding and ownership-transfer funding, the recommendation should show how each need is addressed, including any deliberate overlap or limits.

Match covered events to the actual concern

Death, a specified critical illness and temporary inability to work are different events. A life policy does not generally become general absence cover simply because the insured person is essential to the business.

Ask which events trigger payment, what definitions and exclusions apply, and whether any additional benefit is optional. Confirm the term and what happens if the insured person changes role, leaves employment or sells their shares.

Underwriting information and the business's financial relationship with the insured person need to be accurate. The policy and legal arrangement should reflect the real situation rather than an application description chosen to produce an attractive quotation.

Coordinate tax, legal work and continuity planning

Do not assume premiums are deductible or proceeds tax-free in every arrangement. Ask the accountant to explain the treatment of both sides and whether the insured amount needs to reflect any tax effect.

Insurance also does not replace operational preparation. Documenting processes, delegating relationships and identifying temporary management can reduce the disruption itself. Funding and continuity measures work on different parts of the problem.

Review the arrangement when ownership, business value, borrowing or key roles change. A useful review confirms that the documents, policy amounts and intended recipients still describe the same plan.

Related reading: business protection advice, financial planning for business owners and financial advisers and accountants.