When you go into business with another person there’s always an element of risk involved.
One of the big risks that no-one wants to think about, is what would happen to the business if one of the partners became critically ill and could no longer continue in the company, or one of the partners died.
During what would already be a personally tragic situation, it could pose a serious risk to the company’s future, as well as the livelihoods of the people working there.
Partnership Protection Insurance can help remove many of the uncertainties surrounding a company’s future in the event of the illness or death of a partner, ensuring a smooth transition of control to the remaining partners.
In this blog, we’ll go through the details of Partnership Protection Insurance and why it could be a good idea for your business.
What exactly is Partnership Protection Insurance?
Partnership Protection Insurance is a form of life insurance that is taken out on each partner in the business.
If one partner dies or becomes too ill to carry on in the business, the Partnership Protection Insurance will provide the finance for the remaining partners to buy their interests in the business and retain control of their company.
Who can use Partnership Protection Insurance?
Partnership Protection Insurance is typically used by any company registered as a partnership, and also limited liability partnerships.
It’s essentially suitable for any company in which the owners are registered as a partner with an interest in the businesses, rather than shareholders in the business.
For businesses with shareholders, shareholder protection insurance might be more suitable – although the two types of policy work in much the same way.
Why is Partnership Protection Important?
The main reason you should have a partnership agreement along with insurance, is because of the rules surrounding partnerships in the event of a death or illness.
According to the Partnership Act 1890, without an agreement or insurance in place, a partnership will be automatically dissolved in the event of a death – even if multiple partners remain.
The outgoing partner’s interest will typically be calculated based on their share of the business and its assets, with the amount going to their beneficiaries – usually their family.
This could potentially lead to a few scenarios that are not ideal for the business, or the remaining partners.
For example, the beneficiaries of a partner’s interest may have no knowledge or experience in the company, but could retain the interest they inherit and take a share of the company’s profits.
They could do this even if they have no involvement in the running of the company.
For the remaining partners, they would want to buy this interest in the company back to retain control of the company and not split profits with a third party who has no involvement in the business.
For the beneficiaries of any interest, they might not want any involvement in the company, but would still want a fair valuation for the interest.
With Partnership Protection in place, they would sell their interests to the remaining business partners, and get that fair value they want.
How does it work in a limited partnership?
If the business is run as a limited liability partnership, the buy and sale of interest would work the same.
With one difference.
With no agreements in place, under the Limited Liability Partnership Act 2000, the beneficiaries or representatives of the deceased partner wouldn’t be able to be involved in the running of the company.
But they’d still be entitled to the same financial benefits the partner would have been.
This would create a situation where the remaining partners would want to buy the interest in the company back to avoid taking on a silent partner who they had to share profits with.
A Partnership Protection Agreement, along with the relevant insurance, would allow them to do this.
How to set up Partnership Protection
The first thing to be aware of when setting up Partnership Protection, is who will inherit a partner’s share in the business and what they’ve set out in their Will.
Understanding who the interest in the business will be gifted to can help ensure the purchase of the interest can happen quickly – as each party has already been identified.
Second, it can also help make the process more tax efficient and ensure that any business property relief for inheritance tax is applied.
When setting up Partnership Protection, the arrangement should have a number of key elements.
First, it should state how each partner’s interest in the company will be calculated and valued, as well as the right of each party when it comes to the sale and purchase of the interest.
This calculation method needs to be agreed up front to avoid any disputes down the line.
Second, each partner will need to take out insurance cover (Partnership Protection Insurance). We’ll cover this in detail in the next section, but this essentially ensures the funds are available to the remaining partners to buy the interest back when the time comes.
Finally, it should be structured to take advantage of the business property relief and inheritance tax breaks we’ve already mentioned.
When it comes to the type of Partnership Agreement you’ll use, there are a few to choose from.
Which you choose will depend on preference and the individual circumstances of your company.
One option could be to use an automatic accrual.
Under this option, there is no buy or sale of interest and it simply passes straight to the remaining partners.
Another option would be a buy and sell agreement.
In this scenario, in the event of a partner’s death the remaining partners must purchase the interest, and the outgoing partner’s estate must sell.
The other option would be a cross-option agreement.
Here each party would have the option to buy or sell the interest in a company, but there would only be a legal obligation to do so if one party executed their rights within the agreement.
For example, if the remaining partners wanted to buy the interest back, the estate would have to sell regardless of whether they wanted to or not.
Why do you need Partnership Protection Insurance?
Setting out an agreement that dictates what will happen to a partner’s interest in a business in the event of their death is one step, but the remaining partners still need the money to fund the purchase.
Without Partnership Protection Insurance in place, these funds would either need to be found within the business, or from personal savings.
In either case, if the interest is worth a significant amount, it’s unlikely the funds would be available without putting the business’ or each individual partner’s finances at risk.
With Partnership Protection Insurance, there’ll be a guarantee of funds available to ensure the smooth purchase and transition of any interest back to the remaining partners so they can maintain control of the company.
How will Partnership Protection Insurance be calculated?
The value of each partner’s interest in the company will be determined prior to signing an agreement using a formula to calculate the value.
Typically the interest will be worked out using the average partnership profits over a certain period, for example, five years, and using a multiplier to determine the value for the purpose of buying or selling the interest.
The company’s net assets could also be used in the calculations.
Take out your Partnership Protection with Rigby Financial
The death of a business partner isn’t something anyone wants to think about.
But when you’ve got your own and any employees’ families lives to think about, there’s a responsibility to protect the future of a business under any circumstance.
Using Rigby Financial to take out your Partnership Protection Insurance, ensures you’ll have expert guidance and advice throughout the process to ensure you get the best deal and the right outcome for you and your business.
If you want to know more, get in touch
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