Understand why insurance combined with
carefully drafted shareholder agreement clauses are powerful tools for helping
protect the value your businesses.
Most
of the entrepreneurs that we meet are generally optimistic about their businesses’
prospects. The majority of their time
and resources are spent working towards the future success of their
business. Most businesses are required
to carry general commercial liability insurance by their landlords or other
third parties, and in some cases business interruption insurance. However, it is very common for entrepreneurs
to believe the benefits of obtaining other types of insurance to protect
against events that will “never happen” to
them or their co-founders is vastly outweighed by the costs of planning,
obtaining and maintaining such insurance.
Unfortunately
death, disability or liability may arrive at some point for any entrepreneur
regardless of age and experience. Having
the appropriate type and amount of insurance in place allows entrepreneurs to reassure
stakeholders with a vested interest in the success of the business such as customers,
employees and investors that the business will continue to have sufficient
funds to keep operating even in the face of tragic circumstances.
We
don’t sell insurance but have witnessed the less-than-optimal consequences of
inadequate insurance coverage or improper structuring. Over the years, we have reviewed and revised
hundreds of shareholders agreements that completely ignore the important
protective role of insurance to a business, leave the decision about obtaining
and maintaining insurance to the board of directors, or used precedent
insurance provisions which result in the insurance proceeds flowing to the
wrong entity. In response to these
drafting shortfalls, we’ve created the following chart to help entrepreneurs
better understand why insurance combined with carefully drafted shareholder
agreement clauses are powerful tools for helping protect the value of their
businesses.
|
Type of insurance
|
Owner/Beneficiary
|
Sample Shareholders Agreement Terms:
|
|
Key
person life insurance: Example #1
|
-
Company owns and pays the premiums for insurance on the life of the company’s
key person
- Company
is the beneficiary of the insurance proceeds on the death of the key person
-
Proceeds can be recorded in the capital dividend account of the company
|
- Schedule
listing the particulars details of the life insurance policy
-
Requirement and process to be followed for company to use the life insurance
proceeds to buy the shares from the deceased key person’ estate
-
Procedure/formula for calculating share value on date of death (excludes
value of insurance proceeds)
-
Procedure for applying for additional life insurance if the share value
increases prior to death
-
Terms for payment by company of difference between share value and the
insurance proceeds
- Company ability to use surplus insurance
proceeds to hire a replacement for the key person
- Option
to assign insurance policy to individual if key person departs prior to
death, in return for a payment to the company
|
|
Key
person life insurance: Example #2
|
-
Co-founder A owns and pays the premiums for insurance on the life of
Co-founder B
- Co-founder
A is the beneficiary of the insurance proceeds on the death of Co-founder B
|
-
Schedule listing the particulars details of the life insurance policy
-
Requirement and process to be followed for Co-founder A to use the life
insurance proceeds to buy the shares from Co-founder B’s estate
-
Procedure/formula for calculating share value on date of death
-
Procedure for applying for additional life insurance if the share value
increases prior to death
-
Terms for payment by Co-founder A of difference between share value and the
insurance proceeds
- Option
for Co-founder A to lend surplus insurance proceeds to the company to hire
Co-founder B’s replacement
-
Option to assign insurance policy to Co-founder B if he or she departs the
company prior to death, in return for a payment to Co-founder A
|
|
Key
person disability insurance – Example #1
(often
supplemented by business overhead insurance and business loan insurance)
|
-
Company owns and pays the premiums for insurance to protect against illness
or injury of the company’s key person
-
Company is the beneficiary of the disability insurance proceeds
|
-
Schedule listing the particulars details of the life insurance policy
-
Defines “disability” and trigger for purchase of shares from a key person
with a disability
-
Requirement and process to be followed by company if using the disability
insurance proceeds to help compensate the company for revenue loss including
the payment of debts and to find and a replacement for the key person, and/or
to buy shares from the key person
-
Procedure/formula for calculating share value on a certain date
-
Procedure for applying for additional disability insurance if the share value
increases prior to disability
-
Terms for payment by Co-founder A of difference between share value and the
insurance proceeds
-
Option for Co-founder A to lend surplus insurance proceeds to the company to
hire Co-founder B’s replacement
|
|
Key
person disability insurance – Example #2
|
- Co-founder
A owns and pays the premiums for insurance to protect against career-ending illness
or injury of Co-founder B
-
Co-founder A is the beneficiary of the disability insurance proceeds
|
-
Schedule listing the particulars details of the life insurance policy
- Defines
“disability” and trigger for purchase of shares from Co-founder B
-
Requirement and process to be followed for Co-founder A to use the disability
proceeds to buy the shares from Co-founder B
-
Procedure/formula for calculating share value on a certain date
-
Procedure for applying for additional disability insurance if the share value
increases prior to disability
-
Terms for payment by Co-founder A of difference between share value and the
insurance proceeds
-
Option for Co-founder A to lend surplus insurance proceeds to the company to
hire Co-founder B’s replacement , to pay off debts, etc.
|
|
Errors
& Omissions/Professional Liability Insurance
|
-
Company owns and pays the premiums to protect its professionals from their
exposure through their work to any liability caused by negligence, error,
failure to do something, etc.
- wide
range of policies but some cover claims from third parties alleging financial
loss due to the sale of your product, including related risks like breach of
intellectual property
- Must
choose whether beneficiary is company or professional
|
-
Schedule listing the particulars details of the E&O policy
-
Requirement for policy to cover “claims” against company, employees and
subcontractors, not just “suits”, and to include legal defense costs prior to
the final outcome, and judgments
-
Requirement for board of directors to review the insurance policy coverage on
a regular basis to ensure adequacy of coverage as the business changes
|
|
Directors
& Officers Liability Insurance
|
-
Company owns and pays the premiums to protect its directors and officers from
liability resulting from their decisions and actions taken in their roles
with the company, other than fraudulent, criminal or
intentional
non-compliant acts
- Must
choose whether beneficiary is company, director or officer
|
-
Schedule listing the particulars details of the D&O policy
-
Requirement for policy to cover “claims” against company, employees and
subcontractors, not just “suits”, and to include legal defense costs prior to
the final outcome, and judgments
- For
arm’s length directors, adequate D&O liability insurance may be a
condition for their continued participation on the company’s board
-
Board members may require management to certify on a regular basis that the company
is in compliance with laws, policies, etc. and that the insurance premiums
have been paid
- Requirement
for the purchase of a “run-off policy” for an additional premium granting
cover for claims for a certain fixed time period after the date of and
acquisition transaction
|
One
final word to the wise entrepreneur: Be
clear about your business goals when you are speaking with your insurance
provider and ensure that he or she is in communication you’re your other
professional advisors. They should be
working as a team to ensure that when reality strikes, you and your business
are not only adequately covered by insurance but that the proceeds of insurance
are received and used in a manner that achieves your business objectives.