Partnership Protection Agreements: Securing Your LLP
Speak to An ExpertCustomers love us! Don't take our word for it. Check out what some of them have to say...
Is Partnership Protection Suitable for Your Firm?
Partnership Protection is essential for any business operating as a traditional Partnership or an LLP. It is particularly critical in professional services where the value of the firm is tied to the partners themselves.
Who Needs Partnership Protection?
In these firms, partners often hold significant equity. If a senior equity partner dies, the remaining partners need immediate capital to buy out their share to maintain control of the firm and prevent disruption to clients.
While the Clinician Hub covers this in detail, non-clinical partners in healthcare businesses face the exact same risks regarding the buyout of practice premises and goodwill.
Firms built on the collaborative expertise of a few key partners need assurance that the death of one will not force the liquidation of the firm to satisfy the financial demands of their estate.
Key Financial Risks of Unprotected Partnerships
Operating without Partnership Protection exposes the firm to severe risks:
In a traditional partnership without a deed stating otherwise, the death of a partner automatically dissolves the partnership. The business ceases to exist, bank accounts are frozen, and assets must be sold.
In an LLP, the deceased partner’s share typically passes to their estate. The surviving partners may suddenly have to consult with a grieving spouse who has no professional qualifications or interest in the firm.
Even if the surviving partners have the right to buy the shares, they may not have the personal capital or the ability to raise commercial finance quickly enough to do so, leading to protracted legal disputes.
How Partnership Protection Works
A robust Partnership Protection strategy requires two elements working together:
- The Legal Agreement (Cross-Option Agreement): This is a legally binding document stating that if a partner dies, the surviving partners have the option to buy their share of the business, and the deceased’s estate has the option to sell it to them.
- The Insurance Policy: Life insurance (and often critical illness cover) policies are taken out on the lives of the partners. The payout amount is designed to match the value of their share in the partnership.
- The Trust: The policies are written into a specific business trust. This ensures the payout goes directly to the surviving partners to fund the purchase, rather than forming part of the deceased’s estate.
Case Studies
Key Considerations
When setting up Partnership Protection, several factors must be carefully managed:
- Valuation: How is the partnership valued? Is it based on multiples of profit, or the value of underlying assets? This valuation must be reviewed regularly to ensure the insurance cover remains adequate.
- Tax Implications: How the premiums are paid and how the trust is structured can have significant tax consequences. Specialist advice is crucial to ensure the arrangement is tax-efficient and does not trigger unexpected inheritance tax liabilities.
- Critical Illness: Should the agreement also cover a scenario where a partner suffers a severe illness and can no longer work, but has not died?
Speak to a Broadbench Specialist
Partnership protection is a complex area where partnership law, tax planning, and insurance intersect.
Speak to a Broadbench specialist to ensure your firm’s continuity plan is robust, tax-efficient, and tailored to your specific LLP agreement.
FAQs
How is shareholder protection structured?
There are three main ways to set up shareholder protection:
- Own life plans under business trusts – Each shareholder takes out a policy on their own life, written in trust for the benefit of other shareholders.
- Life of another plans – Each shareholder owns policies on the lives of other shareholders.
- Company-owned plans – The company takes out policies on shareholders to fund the buyback of shares.
Speak to your Broadbench financial adviser to determine the best option for your business.
What is a cross-option agreement?
Also known as a double-option agreement, this gives surviving shareholders the option to buy shares from the deceased shareholder’s personal representatives.
- If either party wishes to exercise their option, the other must comply.
- The option can only be exercised after death, within a specific timeframe.
Does a cross-option agreement affect IHT business property relief?
No. If a shareholder passes away while owning shares in an unquoted trading company, 100% Business Property Relief (BPR) may apply for inheritance tax (IHT) purposes, as long as the shares were held for at least two years.
Even if the estate receives cash for shares under a cross-option agreement, BPR is preserved because:
- The option is only exercisable after death.
- There is no binding contract to sell at the time of death.
What happens if shareholders enter into a buy/sell agreement?
A buy/sell agreement would deny Business Property Relief.
- Shareholders agree that, upon the death of one, the remaining shareholders must buy their shares, and the estate must sell.
- Life insurance is taken out to fund the purchase.
Since this creates a binding contract at the time of death, HMRC treats the shares as already converted into cash, making them fully subject to IHT.
How does critical illness affect shareholder protection?
A critically ill shareholder may be unable to contribute to the business and may want to exit. Their co-shareholders will need funds to buy their shares.
- If a business trust is used, a policy with critical illness cover can be written under the trust.
- Instead of a cross-option agreement, a single-option agreement is recommended. This ensures that a critically ill shareholder is not forced to sell against their wishes.
A forced sale could trigger capital gains tax (CGT) and future IHT liabilities, as the shareholder would receive cash instead of retaining shares that may qualify for IHT Business Property Relief.
What happens if the single option is not exercised?
If a shareholder receives a critical illness payout but chooses not to sell their shares, we recommend keeping the proceeds within the trust until the succession issue is resolved.
Although the funds might be available, they were intended for share buyout purposes. Distributing them to the critically ill shareholder could lead to tax complications.
Are there disadvantages to leaving proceeds in trust?
Yes, there is a potential Pre-Owned Asset Tax (POAT) charge.
POAT is an income tax charge applied when someone benefits from an asset they previously owned. While Business Trusts used for shareholder protection fall under POAT, in most cases, the annual benefit remains below the £5,000 tax-free limit.
- The charge is 2% of the open market value of the life plan (subject to official rate changes).
- While the insured person is healthy, the market value is low, meaning no charge applies.
- If they become critically ill and the funds remain in trust, the value increases, potentially triggering POAT.
To avoid this, the settlor (original policyholder) can be removed as a beneficiary of the trust. However, this may have IHT implications, which should be reviewed with a Broadbench adviser.
Secure Your Firm's Future Today
Fill out the form below to arrange a time to speak to a Broadbench adviser who specialises in Partnership/Ownership Protection for businesses.