Succession Planning: Partnerships
The cornerstone of a general partnership is the relationship of mutual trust and confidence between the partners. Managing a partner’s orderly departure from the partnership is essential for business continuity and stability. There’s a lot to consider.
What’s a general partnership?
A general partnership can just happen. You do not need a written partnership agreement to form a partnership (although it is sensible to have one).
General partnerships happen, automatically by operation of law, whenever two or more people (that includes corporate entities) come together with a view to making a profit. They cover unexpected arrangements such as family farm partnerships and other trading partnerships, but they can extend to joint ventures and other collaborative working (whether you want partnership law to apply or not).
If a business is operated as a partnership this can have various legal and financial consequences. This note does not cover all of those consequences but, suffice it to say, unless the partners’ intentions are properly documented in a formal partnership agreement, some of those consequences may be unexpected and unwanted.
What happens when a partner dies?
A properly drafted partnership agreement should deal with what happens when a partner dies. However, if there is no agreement to the contrary the legal default position is that:
- The partnership will dissolve (even if there are multiple partners still left in the business). A dissolution has the potential to cause unwanted banking, contractual and tax consequences. Although rare, in a worst-case scenario, it could force the winding up of the partnership, sale of its assets, payment of debts and distribution of the remaining realised cash.
- The deceased partner’s share will stand as a debt due from the partnership to the deceased partner’s personal representatives. It is an odd kind of debt because, although the partner has died, that partner’s estate can opt to either claim interest on the debt or (if the business continues in reliance on the deceased partner’s capital and assets) to participate in the future profits until the debt is paid.
There are various ways in which to value a partnership share and a partnership agreement can (and should) deal with valuation issues too. However, whatever the value of the share, the default is that the partnership must account to the outgoing partner’s estate for the value of the share. It is important to note that, if the partner contributed land to the partnership and that partner’s family expected to be able to recover that land, unless it was agreed otherwise, they will not be entitled to it (only a cash equivalent). Conversely, if the partnership is using land which belongs to a partner but does not own that land, for business continuity purposes, it will want the ability to purchase or otherwise continue to use that land.
Partnership agreements generally deal with an outgoing partnership share in two ways: either it automatically accrues to the continuing partners or the continuing partners have an option to purchase that share (in each case, at a determined value).
To assist with cash flow, it is usually sensible for a partnership agreement to allow any payments due, following a partner’s departure, to be paid in instalments. If the debt cannot be paid, then the last resort is to wind up the partnership.
What happens if a partner wants to retire?
It may surprise you but there is no general right to retire from a partnership. If there’s no express agreement to the contrary, retirement usually has to be approved by all of the partners.
The same issues arise in relation to a retiring partner’s share of the partnership as they do on the death of a partner.
What happens if a partner won’t retire?
In very simplistic terms, if the partner has not done anything wrong, you cannot force them to retire. Again, if, for succession planning and stability reasons, you would like the option to trigger a retirement then your partnership agreement could provide for that.
What happens if you want to bring in your children?
Generally, the admission of new partners is viewed as so fundamental to the partnership it will require the consent of all of the partners. This is because the foundation of a partnership is mutual trust and confidence between the partners. However, sometimes, in family partnerships, it is agreed that certain categories of partner will be admitted to the partnership as of right. For example, direct lineal descendants of a founding partner may be given the right to be admitted as a partner. Putting clear and understandable rules around when new partners may be admitted can be key to achieving a sensible, orderly handover of the business.
Again, the admission of a new partner can trigger a dissolution of the old partnership unless there’s an agreement to the contrary.
What about incorporation?
Sometimes the partners decide that incorporating the partnership to become a limited company, perhaps even as a Family Investment Company is the best approach to future planning. Not least because property registrations, banking and contractual arrangements can become an administrative burden when a partner dies. Although, there are other administrative burdens which accompany running a limited company.
Incorporating a partnership involves the transfer of the partnership’s assets to a new company. In return for that, the partners are issued shares in the new company. Provided it is done correctly, there should be tax reliefs available on incorporation of a partnership. Your accountant or tax adviser should be able to advise you further on that issue.
To discuss anything above please call Victoria Spellman on 01473 350573, email [email protected] or fill out our enquiry form below.
Victoria Spellman is a Partner in the Corporate & Commercial Team at Barker Gotelee Solicitors.
