A matter of life…
Confronting difficult questions is essential at the outset of a new practice
“In this world nothing can be said to be certain, except death and taxes”. Benjamin’s Franklin’s quote will be known to most of you, and unfortunately it is true that each is inevitable.
When we advise our dental clients on the structure of their practices, we always recommend putting in place appropriate documentation to address the relationships between the principals, which would be a Partnership Agreement where the practice is owned by a partnership, and a Shareholders Agreement where it is owned by a limited company. The two types of document address similar issues, although the exact terminology will vary from one to the other.
One aspect which we always recommend covering is the question of what happens if one of the principals were to die. Aspects to consider include:
Taking appropriate financial and tax advice is really important
- Would the other principal buy the interest of the deceased principal from their estate, and /or bring a new principal in to acquire that interest?
- If so, how will that interest be valued?
- Can the estate of the deceased principal sell to a third party, and if so does the continuing principal have any say in who that is?
These may seem very difficult questions to answer at the outset of a new practice, particularly where the principals are relatively young. Sadly, life (and death) is not predictable, and giving everyone concerned some certainty from an early stage of the practice will hopefully bring some comfort that their business and personal interests are safeguarded for themselves and their families.
The next key question which arises is where the money will come from to buy out the estate of a deceased principal. The continuing principal may not have the necessary funds to pay the estate, and that would be a problem for everyone. They may be able to borrow some or all the money, but that wouldn’t be known until the time comes, introducing another uncertain factor.
Some clients will address this concern by taking out life policies which are then placed in trust for the other principal. For example, in a partnership with Partners A and B, Partner A will insure their own life and place the policy in trust for Partner B, and vice versa. They then put in place a document known as a cross option agreement. In simple terms, this cross-option agreement ensures that either the continuing partner, or the estate of the deceased principal, can require a transfer of the interest held by the estate, in exchange for the funds paid out by the relevant life policy.
This may sound fairly involved but, in reality, these arrangements can be put in place relatively easily. Whilst the policy premium is a cost to the principals, like any insurance it is likely to be money well spent should one of the principals die, giving some certainty and peace of mind to the principals and their families.
It is important that any documentation around the death of a principal, and the policy/cross option arrangements, are properly drafted, as unfortunately there are a number of inheritance tax and other pitfalls should they not be put in place correctly. Taking appropriate financial and tax advice, along with instructing lawyers who are familiar with such arrangements, is really important.
Michael Royden, Partner, Thorntons Law LLP
T: 01382 346222