Why is there a need for partnership protection?
A partnership is defined in section 1 of the Partnership Act 1890 as “the relationship which exists between persons carrying on business in common with a view of profit, other than by way of membership of a body corporate.” There is no longer any limit as to the number of partners a business can have.
Within a partnership, each partner has an interest in the business rather than the ownership of ordinary shares, as would be the case in a limited company structure. In the absence of a partnership agreement, section 33 of the Partnership Act 1890 states that the partnership is dissolved if one of the partners die. The valuation of the deceased partner’s interest is based on their share of the assets of the business.
The valuation of this interest can be difficult and therefore it is strongly recommended that the partnership has a formal agreement which sets out how this value will be established and allows the business to continue in the names of the remaining partners.
In the event of the death of a partner, the beneficiaries of the estate will usually be their family. They may have no experience of running a business and may not be able to contribute to it in any way. In these circumstances they will usually wish to withdraw their share of the capital at the earliest opportunity. Having partnership protection in place ensures that the family can receive a fair value for that interest.
From the surviving partners’ point of view, they will be continuing to run the business with a sleeping partner taking a share of the profits. They will therefore be keen to ensure that they will be in a position to regain control of the business by paying the family their share of the business back as soon as possible. Partnership protection ensures that the partners will have sufficient funds to do so.To be effective, a partnership protection arrangement should consist of three main elements:
- An agreement setting out how the interest will be valued and the rights of each party.
- Insurance cover to ensure the funds are available to buyout the interest.
- A tax efficient structure.
Before reviewing the different types of business agreements in detail, the starting point for any effective partnership protection arrangement should be to consider the individual partners’ own personal wills.
These plans typically have no cash in value at any time and cover will cease at the end of the term. If premiums stop, then cover will lapse.