Why do you need a partnership agreement?
A partnership can be a much more attractive prospect than working alone and can be brought about over a pint at lunch and the shake of a hand, no paperwork needed. However, that does not mean that there are no strings attached…
A partnership is not a separate legal entity like a limited company or limited liability partnership and partners generally have unlimited personal liability. For example, each partner will be jointly and severally liable for all the partnership’s liabilities including debts of any kind so that, like a mortgage where a lender can pick and choose whom to pursue, a creditor may pursue any one of the partners for the whole amount.
Why is a written agreement important?
Just like any other business arrangement, a written agreement clarifies specific points about the running of the business that could otherwise be disputed. So that would include internal considerations such as:
• Recording cash going into the business
• How cash (profit and capital) is to come out of the business
• Who has responsibility for what in the business
• The decision-making processes in general
• What happens if one partner wants to leave, gets divorced or dies
• What happens if the partnership is to be dissolved.
If none of this is recorded up front in a partnership agreement, there is no mutually agreed starting place to resolve what could easily turn into a nasty and costly dispute.
What about tax?
LLPs are ‘tax-transparent’, meaning that they do not pay UK corporation tax or capital gains tax. Instead the income generated by an LLP company is distributed as gross income to the partners, who are registered as self-employed, rather than as PAYE employees.
What happens if there is no written agreement?
Not having a Partnership Agreement leaves you wide open to challenges from your business partner. It also means that your business is governed and protected not by current legislation, but by an Act that is over 120 years old (the Partnership Act 1890). As well as being old and possibly outdated, it is also quite a vague piece of legislation and includes some very unsatisfactory outcomes including:
• In the absence of agreement to the contrary, a partner shares equally in the profits of the business irrespective of the amount of time or effort he or she has put into the business. So even if your partner hasn’t put an ounce of effort into building the business, they’re still entitled to an equal share of the profits.
• A partner cannot retire. If one partner decides to leave or dies, the partnership has to be dissolved; the assets divided up and a new partnership (or other business) formed. Needless to say, this will be an expensive, time consuming and stressful process. It also means, once again, that a less than active partner can simply announce their retirement and effectively cash in on all your hard work.
• A partner cannot be expelled; if this is necessary, the partnership must be dissolved and reformed, which bears many legal complications. So without an agreement they are your partner, whether you like it or not!