Partnership protection

When a partner dies or becomes seriously ill, their interest in the firm does not simply disappear. Their family may want, or need, to be paid for it. The surviving partners usually want to keep the firm under their own control, but may not have the money to buy the share.

Without a plan, the partners might have to borrow, sell assets or bring in an outsider, and the partner's family might wait a long time to be paid. Partnership protection is designed to give both sides certainty: money for the purchase, and a fair value for the family.

Ordinary partnerships and LLPs

The approach works for both ordinary partnerships and limited liability partnerships. In each case the partnership agreement, or LLP members' agreement, is the starting point, because it sets out what happens to a partner's interest when they leave, die or can no longer work. If the agreement is silent or out of date, that is worth fixing first.

Own-life policies in trust

A common arrangement is for each partner to take out a policy on their own life, written in trust for the other partners. If a claim is made, the payout goes to the trustees for the continuing partners, who use it to buy the share. Because the policy is in trust, a death claim can usually be paid to the trustees without waiting for probate.

A cross-option agreement

The policies are usually paired with a cross-option agreement. This gives the remaining partners the option to buy the share and the partner's estate the option to sell, so either side can make the purchase happen. Where critical illness cover is included, the options are usually set up differently, because the partner is still alive. Your solicitor drafts the agreement to fit the partnership agreement.

Other structures exist, such as policies owned by the partnership itself, and the right choice depends on the firm. If your business is a limited company, see our page on shareholder protection instead.

The main factors are:

• •The value of each partner's interest, usually worked out with the firm's accountant
• •The valuation basis set out in the partnership agreement
• •Whether to include critical illness cover, which increases the premium
• •Each partner's age, health and smoking status, which affect the price of their policy
• •How long the cover needs to last, for example until a planned retirement

The value of the firm changes, and so do the partners. Reviewing the valuation, the cover and the agreements regularly, and whenever a partner joins or leaves, helps avoid a shortfall or cover that no longer matches the partnership.

Critical illness cover pays only when the illness meets the policy's definition, and definitions vary between insurers. A partner who is seriously ill but does not meet the definition would not trigger a claim. Our guide on why people consider critical illness cover explains how definitions work.

The tax treatment of the premiums and payouts depends on how the arrangement is set up and the partners' circumstances, so ask your accountant to confirm it.

Check what your partnership agreement says about a partner's death or serious illness, and ask your accountant for a current value of each share. We can then compare policies from our panel, recommend how they should be owned and held in trust, and coordinate with your solicitor so the insurance and the agreements work together.