Is Your Firm At Risk? - Financial News Autumn 2007

01 October 2007

If you are a partner in a firm, have you considered the implications to your business if one of your partners dies?

The partner’s beneficiaries will probably be his or her family, and the estate will include his or her share of the business.

The surviving partners will want to continue running the business, but ideally without the deceased’s family taking profits as sleeping partners. Indeed the deceased’s relations may insist on becoming involved in running the business, despite maybe having no experience or qualifications. Most likely, however, the deceased’s family will just want to ensure that they receive a fair price for the business share, and as quickly as possible. One option is for the firm to pay out of reserves or profits, another to borrow the money at a potentially difficult time for the firm. The better option is to make sure the firm has the required cash when it really needs it.

The firm should ensure that it is protected by implementing the following:

• An agreement setting out how the partners’ interests will be valued, allowing the remaining partners the right to buy the interest in the business.
• Life insurance cover to ensure that funds are available to buy out the deceased partner’s interest.

Firms may consider putting a “buy and sell agreement” into place. This means that the remaining partners must buy the deceased’s interest in the business and the deceased’s estate must sell. It should also place an obligation on each partner to take out life cover in trust for the benefit of their fellow partners.

A less rigid approach is to take out a “cross option agreement” where each party has the option to compel the other party to either buy or sell. There is usually a period within which this option has to be exercised. If the firm were to consider cover in relation to the critical illness of a partner as well as death, it is usually desirable that the less stringent cross option agreement is used. This could then enable the sick partner to return after his or her recovery. It also allows the deceased's estate to benefit from Business Property Relief.

There are no real tax consequences as the premiums will be paid directly by each partner out of their taxed income. If a qualifying plan has been used, there will be no tax liability on the death of the life assured. There is no tax chargeable event in relation to critical illness.

Of course small limited companies would suffer many of the same problems if a shareholding director were to die or suffer severe illness. However the structure of the life and critical illness cover would be different.

For more information please contact Simon Ludden, Financial Planning Manager.
 

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