Partnership Agreements – Easy As?

Solution written on blackboard with lightbulb

Ok, so not so easy but if done quickly it may SEEM EASY just not effective.

One area of concern addressed in a Partnership Agreement is death of a partner. As tragic as it is, there is simplicity due to the fact that death is very definitive. What's not so definitive is how does the surviving partner or partners end up taking over the deceased partners interest in the business so life can continue.

Getting partners to agree to something is the first task and one solution is a gunshot agreement. This is where an amount is set that the partners agree to in buying out the other in the event of a death. It's effective as long as no survivor and or benefactor disagrees. Even though the partners agreed the surviving benefactor may be in a position to contest the agreement. Example: business is worth $1,000,000, 2 partners agree to a gunshot deal paying the survivor partner off with $500,000 and took out term life insurance of $500,000 each to fund the agreement. Ten years go by and the business valuation sky rockets to $5,000,000. How is it fair that $500,000 buys out a partner and the family and or beneficiaries with 10% of the value of the business? Obviously, it is not fair and that’s why we quarterback cases for clients to address the wishes of the living and protect the interest of the deceased.

Enhancing the agreement to include FMV (Fair Market Value) valuations 2 or 3 and taking the average, deducting the insurance proceeds and coming up with a balance works. The key is stipulating the agreed upon method in the partnership agreement. It balances out any inequities whether it be positive or negative. There real question is how do we satisfy a buyout if a partner becomes sick or has a serious accident. Now we are having to think outside the box.

In principal the above can work in coming up with numbers.The problem is determination of a sickness or accident such that a buyout can be triggered. Again, it's partners agreeing on something and making it formal in the partnership agreement. When insurance is utilized I like to leave the determination process left to an insurer if possible. Example: using the same numbers above the partners take out buy sell disability insurance and this typically comes with a one year waiting period and in this case a $500,000 lump sum payout plan can work.In addition, most professionals protect their personal income with long term disability insurance and in this case let’s assume both partners have $7,000 per month that includes a 90 waiting period. Waiting period options range from 30 to 365 days.

Now possibilities emerge, if it is determined by the insurer, in the event of a claim, that the $500,000 lump sum buy-out benefit and or the $7,000 per month disability benefit is to be paid then the buyout is triggered. As this is a definitive third party assessment it lends credibility to a just and fair process.The agreed method would need to be formally addressed in the partnership agreement. Without any insurance in place or agreed format to determine the extent of a sickness or accident of a partner it becomes problematic and difficult for a partnership to survive.

With the buy-out insurance having a one year waiting period the above method makes total sense but the disability insurance plan may not, depending upon the waiting period. Some mature companies can afford to carry a partner therefore implementing a six month waiting period may be one solution but for that young company with partners having a young family the income replacement benefit may be needed sooner than later thus the buy-out method solely may facilitate the partnership agreement best for now and at such time as partners age the agreement along with an insurance policy can be amended accordingly. It's all about “the now” and flexibility to roll with the times. Bottom line, partners must agree to something and that is the starting point with any partnership agreement.