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Partnership Agreements- The Vital Ingredient

How can a partnership agreement benefit a farming business? John Rouse, partner in Lodders’ Private Client and Agriculture teams, discusses.

The most common business model for a farming business is a partnership.  In its simplest form, this is a number of individuals working together.  As most farming businesses are family enterprises the need for a formal partnership document is often overlooked and deemed an unnecessary additional expense.

However, in modern day agriculture, the benefits of a properly drawn up partnership agreement should not be overlooked.

The benefits of a partnership agreement include:

  • An agreed structure for decision making
  • Allocation of income and capital profits between the partners
  • Providing a structure for exiting the business
  • Dealing with the death of a partner
  • Options to buy the business
  • Treatment of partnership capital
  • Maximising tax efficiency

Decision Making

Whilst most day-to-day decisions don’t require a partnership agreement, certain key decisions such as selling land, major purchases, admission or expulsion of partners and authority for certain expenditure can be documented to prevent dispute or arguments at a later date.

Exiting, Death and Incapacity

Partnership businesses are very vulnerable where one of the partners dies or wishes to exit the business.  On the death of a partner, their partnership share will often pass to his or her spouse or family.  Unless those wider family members wish to remain in the business they will often seek to withdraw the deceased’s partner’s capital in the business.  In the absence of a partnership agreement, under general partnership law the partnership can be brought to an end and assets liquidated to pay out the deceased’s partner’s family.  This can often prove terminal for the farming business.

A common source of litigation in family businesses is the withdrawal or pay out of capital on a partner’s death or exit of the business.

A partnership agreement can provide a suitable structure to provide certainty for all parties whereby the deceased partner’s family can be paid out, but in a controlled manner, perhaps over a period of time, with an agreed form of valuation.

Where a partner loses mental capacity, the partnership can include provisions for withdrawal of capital to fund long term care, mitigating the sudden requirement for capital.

Options to Purchase – Keeping it in the Family

Many farming businesses are family owned and run.  On the death, divorce, loss of capacity or simply the exit of a partner, there can be a real risk of the farming business moving out of the family.  A partnership agreement will often include an option for the remaining partners to buy out the exiting partner or their family (on death or divorce).  That buy out can be phased over a period of years to ensure a smooth transition.  Whilst the remaining partners will still need to find the capital they will have the comfort of an agreed timetable and the reassurance of being able to keep the business going within the family and without having to admit “outsiders”.  The option can be backed up with life insurance arrangements to fund any buy out on death or critical illness.

The use of such an option provides a perfect balance between ensuring the ongoing viability of the business whilst ensuring and deceased partner’s family or exiting partner gets fair value.

Tax Efficiency

Recent years have seen a far greater focus on farming businesses by HMRC.  Through a succession of tax cases, the availability of inheritance tax agricultural property relief has slowly been eroded increasing the vulnerability to significant tax liabilities, especially where the farming business has diversified or any land or buildings have hope or development value.

A properly drafted partnership agreement can provide a robust structure to maximise the tax efficiency of the business and address common HMRC queries.

The treatment of partnership capital within a partnership agreement can help avoid confusion and also increase the availability of tax relief on your business assets.

Crossover between Business and Personal Planning

For farming families, there is an inevitable crossover between planning for the business and their own personal planning.  Any partnership planning should be dovetailed with a partner’s own personal will and estate planning.  Where there is any contradiction a partnership agreement will generally overrule a will and therefore care needs to be taken in drafting.  Moreover, complimentary partnership and will/estate planning can produce some very efficient tax planning opportunities.  Therefore it is vital to ensure your business planning and personal planning is complimentary.

Is your Partnership Agreement up to date? 

Tax, estate planning and partnership law have been rapidly evolving areas of law in recent years.  The importance of having an up to date, robust partnership agreement can be the vital ingredient between a successful viable business, equipped for the future and a business vulnerable to the vagaries individual partner’s situations and the changing tax landscape.

Your partnership agreement can be the key to ensuring your business thrives and can successfully navigate the inevitable up and downs of commercial life and the individual owners’ personal circumstances.

For more information on partnership agreements or other aspects of agriculture law, contact John Rouse on 01789 206167 or via email.

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Get in touch

For more information on partnership agreements or other aspects of agriculture law, contact John Rouse on 01789 206167 or via email.