A partnership is when two or more people operate a business as co-owners and share income. All partners act on behalf of each other in the business. Like the sole trader structure, a partnership entity is not separate from its operators.
ADVANTAGES OF PARTNERSHIPS
- Partnerships are easier and less expensive than companies to set up.
- Partners may carry on business under the trading (business) name.
- Partnerships combine the resources and expertise of a number of people.
- Partnerships are simpler to administer. Profits and losses are shared between partners according to his/her share (as specified in the “partnership agreement”).
- Unlike companies, partnerships do not have to disclose their profits to the public (i.e. greater privacy.)
- Changing the legal structure is relatively simple (i.e. changing from a partnership into a company at a later stage.)
DISADVANTAGES OF PARTNERSHIPS
- All partners together are personally responsible for business debts. Each partner is individually liable for debts incurred by the other partners. This is known as joint and several liability i.e. unlimited liability.
- All partners have a right to participate in the management of the partnership (unless otherwise agreed.)
- Tax is charged at the personal rate. As business earnings increase, so does the tax rate.
- Partners cannot transfer their ownership to someone outside the partnership unless the other partner(s) agree.
- Personal differences may interfere with business.
It is advisable to have a written partnership agreement. Partnership agreements deal with many matters, but particularly important areas relate to: –
- Business decisions;
- Change of circumstances e.g. death, insanity or bankruptcy;
- Asset protection;
- Sale of the share in the partnership by a proposed outgoing partner; and
- Disputes.
Dealing with the matters individually: –
- Some consideration should be in given as to how the decisions are made i.e. whether this has to be unanimously or by majority in the case of a bigger partnership. Properly drafted provisions allow the partnership to move forward without causing undue disruption;
- A change of circumstances may trigger an event where the remaining partners (assuming there is more than one person remaining) wish to carry on the business without a dissolution taking place. A formula to pay out an outgoing partner (or an outgoing partner’s representative) is essential. A well drafted document can allow the remaining partners some time to do this. Cross partnership life insurance can also provide some level of security in the event of the death of one partner.
- In addition, the way the title to any real property is taken is important in the event of death of one partner. For this reason, a joint tenancy would be advisable with an obligation in the partnership agreement to pay out the deceased partner’s estate at a predetermined figure and over an agreed period;
- It is not unusual for partners simply to lease real property from the property owning partners. This provides a means of asset protection. A well constructed lease is also worth considering
- There are some very clever formulas which allow an outgoing partner to make an offer to the remaining partners to sell is his or her share in the partnership, but placing obligations on the remaining partners if they do not purchase that share; and
- Disputes can cause untold damage to a partnership with time expended, inability of the partnership to move forward and of course cost. A well drafted dispute resolution clause can save a great deal in the long run.
The partnership agreement deals with a great many other matters including partnership shares, financial contributions, loans by the partners and duration of the partnership.
It is always a good idea for prospective partners to draft a detailed business plan. The terms of that plan can also guide the partnership agreement.
It goes without saying, but should always be pointed out that accounting advice should be obtained. In addition, the advantages and disadvantages of the partnership structure versus a corporate structure or a corporate trustee structure should be considered with both a legal adviser and an accountant.
A practical word of advice is that for husband-and-wife partnerships or family partnerships, you should decide how the partners will work with each other and the consequences of any disagreement. For partnerships involving non-family members, it is always a good idea to get to know your partner(s) before entering into the partnership.
Now is therefore a good time to consider the way forward with your legal adviser and accountant.
DISCLAIMER
This article contains information about partnerships. The information is not advice and should not be treated as such. You must not rely on the information in this article as an alternative to legal and financial advice from a properly qualified professional. If you have any specific questions about any legal and/or financial matters, you should consult an appropriately qualified professional.
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