Share issues
Many dentists working in partnership or trading as a limited company may not have considered the financial impact on their business and importantly on their financial dependents, if a partner dies or becomes seriously ill. By implementing some simple measures you could protect your financial dependents, yourself and the value of your business.
Case study – partnership protection
Three partners, goodwill and equipment valued at £600,000. Practice property valued at £300,000. Total value of £900,000.
One partner dies, leaving a 1⁄3 share of the practice and freehold to his surviving spouse, who is a non-dentist. The two surviving business partners would like to purchase the deceased business partner’s share of the business and freehold from the surviving spouse. Unfortunately the two surviving business partners have substantial bank borrowings from previously financing the purchase of their own partnership shares. They also have significant borrowings relating to personal residential mortgages. Their partnership agreement doesn’t clearly state how the business should be valued.
From the surviving business partners’ point of view:
1. Due to the recent banking crisis they struggle to raise the £300,000 required to purchase the deceased partner&rsquos share at a competitive rate. Their own retirement plans haven’t allowed for the costly repayment of the additional loan.
2. They can’t find a suitable successor (internal or external) who has the financial means to ‘buy into’ the partnership.
3. There may be a suitable successor but a ‘fair value’ cannot be agreed with the deceased partner’s spouse as there is no provision for this in the partnership agreement.
4. The deceased partner’s spouse agrees to sell the newly acquired share to an external third party. As the partnership agreement doesn’t cover this eventuality, the surviving business partners are powerless to stop this.
5. Due to probate there is a delay of 12 months before the surviving spouse is able to sell their inherited share. The partnership agreement does not give any guidance on how the practice should be valued. As a result of this valuation the surviving spouse expects the surviving business partners to pay more than they feel is fair value.
From the surviving spouse’s point of view:
1. The surviving spouse and surviving business partners dispute the value of the practice and can’t agree a sale price.
2. Due to probate the sale of the newly-acquired share is delayed by 12 months. Unfortunately the surviving spouse is reliant on this capital for income and has to make alternative arrangements.
3. The surviving business partners can’t raise the finance required to purchase the deceased’s share of the practice. The surviving spouse has no option but to accept a lower price or enter complex negotiations with a third party, incurring legal costs and further delay.
The solution
1. A life policy written under trust is taken out by each partner as follows:
Life…………..Sum………….Trust
assured……..assured……..Beneficiaries
Partner A……£300,000…….Partner B and C
Partner B……£300,000…….Partner A and C
Partner C……£300,000…….Partner A and B
On the death of any partner the surviving business partners benefit by a tax-free amount of £300,000.
2. A cross-option agreement is signed by all three partners. This means if the surviving partners offer to buy the deceased partner’s share the surviving spouse must sell. If the surviving spouse wishes to sell the surviving business partners must buy.
3. The partnership agreement is revised to include reference to the cross option agreement, binding all three business partners to its effect.
Critical illness cover can be added to this arrangement, ensuring that the practice and partners are protected in the event that a partner becomes seriously ill.
These simple measures ensure that the practice can continue to operate without the distraction of a legal dispute, or the uncertainty and cost of raising finance. Importantly all partners will have peace of mind that their financial dependents have been adequately protected.
PFM offer independent financial advice exclusively for dentists and dental Partnerships/ Limited Companies. Visit http://www.pfmdental.co.uk for more information or call 01904 670820 to review your partnership protection requirements. PFM also offer a practice valuation service across Scotland, England and Wales.
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