Shareholders and Partners in Business
The consequences of death or disability (from the family business point of view)The Problem
What happens when a business partner, who is also a close family member dies, and what can be done to best protect the family? What happens if the person with a significant control of the business suddenly becomes incapable (for whatever reason) of carrying on?
Being in the position of having to deal with the death or sudden disability of a partner, who is also a close relative, possibly spouse, will create not only emotional turmoil, but could lead to the business entering both a financial and managerial crisis.
The requirements to alleviate the problem
The first main requirement - A Partnership or Shareholders Agreement
A partnership is regulated by either a “Partnership Deed” or “Partnership Agreement”, which is a legally binding contract between the parties concerned. If neither have been entered into then the provisions of the Partnership Act 1880 automatically apply – which is really not satisfactory for today’s businesses!
If there is no partnership agreement to the contrary, death will automatically lead to the dissolution of the partnership, so if it has two partners, the business will automatically have a sole trader status. If it has three or more partners, a new partnership may immediately commence. So the first line of defence to ensure the business is protected, is to get a partnership agreement signed, or get it reviewed and/or amended, if it has not been done for years.
A Limited Company is regulated by the Memorandum and Articles of Association. In addition there should be (but often isn’t) a Shareholder’s Agreement which regulates certain matters between the shareholders themselves as individuals, as opposed to the purpose of the business and how its day to day handling is undertaken
The Partnership Agreement and the Shareholder’s Agreement should include amongst other things how a partner or shareholder and their estates will be paid their share of the business in the event of retirement or death, and how the business share of the outgoing partner/shareholder is reallocated.
The second main requirement - A Will
In order to regularise what will happen from a financial perspective in the event of death it is important for partners or shareholders to have Wills prepared and then reviewed on a regular basis, so that everyone knows who’s going to get what, and how the value of things are to be determined.
If it’s a husband and wife partnership/company, you can assume that the partnership/shareholder interest will automatically pass to the spouse, without any tax complications or cash consequences, unless he or she dies soon after, when inheritance tax can severely reduce the value of the combined estate.
However, if for example a husband and brother partnership/company, and the husband dies, then the brother (subject to the terms of any partnership or shareholder’s agreement) has to effectively pay out the market value of the husband’s share. How is this going to be achieved?
Having a partnership/shareholder’s agreement and a Will in place is the essential framework. But what of the practicalities of the payout?
The third (desirable) requirement - The life insurance policy
Basically, if there is no life insurance policy in place (keyman or otherwise) then (in the husband/brother scenario) the brother will face the prospect of raising the finance to buy out the spouse, or selling assets to do so. Can he, or the business, afford this cost? Invariably the answer will be no, therefore there will be a strong prospect of the family business being broken up.
If keyman insurance is in place for the benefit of the business, then the partners need to be aware that unless the policies are written in trust for the beneficiaries (ideally the spouse), if tax relief has been claimed on the premiums paid, then the eventual pay out may be subject to Inheritance Tax. The potential £500,000 may therefore only end up as being £300,000 – so beware!
If there’s a concurrent death of husband and wife (partners of the same business or not), any surviving children will need to be provided for, but then there’s also inheritance tax and trust issues to be considered. Comprehensive advice and planning is a must, where children are concerned.
The fourth (important) requirement…Someone in charge? Power of Attorney?
Financial issues may be of little relevance, when the business is managed on a day-to-day basis by the individual who dies. It’s alright getting cash from insurance to deal with the financial implications of partnership shares, but who’s going to maintain the business on a management and operational basis?
If there’s no immediate family member in the wings to take over when the lead partner dies, or he or she has to retire on health grounds, plans need to be put in place for the protection and maintenance of the business (ie progression planning). This is something which will incur cost on a day-to-day trading front, but can the family or business afford not to plan for what might be the inevitable? You need to ensure someone has been formally appointed to make decisions, sign cheques etc. You also need to have in place the mechanism for ensuring that someone with knowledge and an interest in the business has the control. This is where the making of a Power of Attorney now can prevent problems of decision making in the future.
Failing to deal with any of the above issues could lead to creditors, particularly the banks, taking the initiative in protecting their own position, rather than that of the family.
Planning for the worst may be depressing, but spending time and money now may ultimately lead to the salvage of a family in times of crisis.
Review your business now and take legal and financial advice sooner rather than later. Be wise before the event…
Main Contact:
Derby: Simon Richardson
Burton: Nick Green
Leicester: Pat Young