A partnership is created when two or more people come together in business to share profit and losses. Although a written partnership agreement is not required to form a partnership, it is vital to avoid uncertainty and the automatic application of unsuitable statutory law.
A partnership agreement is usually made for relationships of a long term nature. For those who wish to work with a company or individual on a short term basis, a joint venture agreement or consultancy agreement may be more appropriate.
Do I need a Partnership Agreement?
Without a partnership agreement the actions, powers and rights of each partner are controlled by the Partnership Act 1890, the provisions of which may not reflect your desired arrangement. The Act has many provisions but those which can have a significant effect include:
- All partners are entitled to share the profits equally no matter how much capital, effort or skill they bring into the business.
- Any partner can bring the partnership to an end just by giving notice to all the other partners. It is also dissolved if a partner dies.
- All partners are jointly and severally liable for the liabilities incurred by the company. This means that if a debt cannot be paid then the creditor can pursue all the partners individually and one may be forced into the position of paying the whole debt by themselves.
- Should a partner get into financial difficulties then their creditors can take assets from the partnership to settle them.
- All partners are considered “agents” of the business and act on behalf of the other partners. They can enter into contractual and financial arrangements which are not good for the business but these will be binding.
- All partners have an equal say in the business and decisions can take time or the business break down in the event of a severe dispute.
Partnerships do have their advantages which include:
- Each partner is able to specialise in their own area of the business
- More finance can be raised than by sole-traders as more owners are investing in the
business. As it is often a larger business than a sole-trader, it often has a better chance at generating other sources of finance e.g. bank loans, etc
- There are no legal formalities to complete prior to starting the business
- Partners can cover each other during times of absence, e.g. holidays or illness
Types of partnership
The are three different types of partnership:
Two or more individuals as co-owners of a for-profit business. All partners are responsible for the liabilities and debts of the partnership. For tax purposes, partnerships enjoy single taxation. Income is reported as part of each partner’s personal income.
A general partnership which elects to operate as an LLP. Unlike a General Partnership, the partners in an LLP enjoy protection from many of the partnership’s debts and liabilities. For tax purposes, the income of an LLP is taxed in the same manner as a General Partnership.
A partnership with at least one General Partner and one Limited Partner. A limited partner’s liability is limited to the amount invested, while the General Partner(s) assumes all the liabilities and debts of the partnership. For tax purposes, the income is taxed in the same manner as a General Partnership.
What should a Partnership Agreement include?
The aim of a partnership agreement is to provide a written structure for your business with respect to each partner’s responsibilities, rights, profit/liability sharing, entering and leaving terms, and also the terms on which disputes are resolved and the partnership can be terminated. Each agreement will vary according to the nature of the partnership but some of the topics that should be covered include:
- Ownership interest
- Loans by partners
- Allocation of profits
- Duties of partners
- Salaries & compensation
- Borrowing money
- Power of attorney
- Admission of new partners
- Leaving or retiring
As you can see, it is folly to operate a business under any partnership basis without an agreement in place. If you’re thinking of forming a partnership and would like further advice, speak to a member of the Truelegal team.