A business partnership is created when two or more people (or entities) decide to own a business together, sharing in the profits and losses.
Structuring the business partnership needs careful consideration, so that all partners are aware of their responsibilities, obligations and profit/loss allocations.
Without a well-structured partnership agreement, the business may fail and your interests may not be protected.
Partnerships account for 7.5% of all businesses in the UK, with approximately 414,000 partnerships in total. This is a significant percentage of people, yet over 70% of partnerships end up failing over time.
A successful business partnership requires complementary skills, knowledge and strengths to help the company achieve common goals, but circumstances and attitudes of the partners in the business may change and this can cause dissatisfaction.
Unfortunately, many partnerships do not have a comprehensive partnership agreement in place, and this means that the nature of the relationship is not legally agreed. The absence of a partnership agreement can result in an imbalance in the split of responsibilities, profits, losses and damages leading to the collapse of the partnership and business.
What is a Business Partnership?
In a partnership, two or more partners work together to carry out the business operations. If the partnership falls below two people (ie, there are two partners and one retires) then the partnership may be automatically dissolved unless a new partner is appointed.
The benefits of having a business partnership include:
- It facilitates shared ownership and responsibilities
- Profits are shared (and so are the losses)
- Experience and knowledge is shared
- Greater funding options when bringing new partners in
- Partners retain control of the business
- Partners combine financial resources and skills
- Sharing the administrative paperwork involved with having a business
Who is in Charge?
Who is in control depends on the which of the 3 main types of business partnerships yours is:
- Ordinary Partnership – all partners are jointly and severally liable.
- Limited Liability Partnership (LLP) – a mix between an ordinary partnership and a limited company. An LLP is an incorporated company, and members are not personally liable for debts and losses of the partnership (the LLP is).
- Limited Partnership (LP) – not an incorporated company but certain partners can be designated ‘limited partners’ who have limited liability. They are only liable for the capital they invest in the business.
How you structure your partnership affects who is in charge.
Common Problems with Informal Partnerships
There are instances where people enter into a partnership, but do not formalise them with a legal agreement. Legally, if two people work together without a partnership agreement in place, the relationship is governed by the Partnership Act 1890.
Without a written partnership agreement, partners place themselves at risk of not having defined roles and responsibilities and an unfair split of the profits.
As an example, if two tech-founders work together, but one of them pays for all the equipment, invests money into the business, does most of the work and trains up the second partner; without a partnership agreement, the default position in the Partnership Act may be that each partner has an equal share.
This means that the partner who has invested more into the partnership in terms of money, equipment and knowledge, will not have any right to a greater share. Also, the assets of the partnership may be shared equally among the partners.
Informal partnerships can result in disagreement between the partners for some of the following issues:
- Who does what work?
- How much each partner has contributed?
- Who owns the assets?
- How the profits and losses should be split?
- Who owns the intellectual property rights and goodwill?
- Partners not consulting each other properly before making decisions
Who Is Liable For A Bankrupt Partner?
Another major consideration for partners is what happens if one partner ends up bankrupt. In the absence of a partnership agreement setting out what happens in a bankruptcy situation, the default position of the Partnership Act is that the partnership will be dissolved ‘by the bankruptcy or death of a partner’.
This may not be what the partners want, particularly if there are existing obligations.
Whilst all partners are not liable if one partner becomes bankrupt, the creditors may be entitled to the bankrupt partner’s shares in the business. The creditor could opt to become a silent partner in the business, sharing profits and losses, or they can enforce a sale of the assets so that the bankrupt partner’s share can be cashed out.
Why Every Partnership Should Have a Partnership Agreement
For any partnership it is essential that a partnership agreement is entered into.
The partnership agreement outlines the roles and responsibilities of the partners, and also sets out important issues such as the split of profits, the decision-making process and how to deal with retirements and appointments.
Without a formal partnership agreement in place, many partnerships can end up wrangling over the legalities and extent of ownership of the partners.
Having a partnership agreement is the best way of protecting your interests and assets in the partnership.
It also ensures that future costs of dealing with any boardroom disputes are significantly reduced, and there is a clear outline of the roles and responsibilities of each partner. Having an agreement in place means that the provisions of the Partnership Act are overridden and partners can take full control of their business as agreed from the outset.
It also means that each partner is aware of what is expected of them from the outset.
Creating a Partnership Agreement
While each business and partner has different requirements, a partnership agreement should cover certain essentials, including:
- Partner appointments and retirements
- Profit and loss distribution
- Ownership of assets and capital
- Decision making
- Termination of the agreement and dissolution
- Duration of the agreement
- Roles and responsibilities
- Liabilities and losses
- Restrictions on the partners
- Management of liabilities and indemnities
- Valuation of goodwill, shares and buyouts
- Payments and expenses
What Are Capital Contributions?
It is important that the agreement sets out the details of each partner, their name, address, and contact details. The capital contribution of each partner should be clearly identified.
A capital contribution is the sum of money or assets paid into the business by each partner. The greater the capital contribution, the greater the partner’s share of equity in the partnership, and a greater the share of profits. The agreement will note each partner’s capital contribution to the partnership.
What are Liabilities and Indemnities?
Liabilities include all the partnership’s debts and any judgements against it. Partners are normally jointly liable for debts. A partnership agreement contains indemnity clauses that may state that the partnership as a whole will take responsibility for any claims against any partners.
The partners can agree to indemnify each other for losses and breaches of the partnership agreement.
Profit and Loss Distribution
Deciding on the profit and loss distribution is an important element of any partnership. After agreeing the annual accounts, partners decide on how the profits and losses should be distributed.
The amount of profit share each partner is entitled to is often based on their capital contribution and should be explicitly referred to in the agreement. If the agreement does not make any mention of profit shares then the partners could be entitled to an equal profit share.
Restrictions and Restrictive Covenants
Your partnership agreement should contain provisions relating to restrictions on partners who leave the partnership. Also known as a non-compete clause, restrictive covenants for leaving partners ensure that they cannot poach clients or staff of the partnership or carry out certain activities.
Restrictions should only affect the legitimate interests of the partnership, so cannot be so wide-ranging that they become void. The most common restrictive covenants are those relating to non-compete and non-solicitation of customers.
Termination and Dissolution
If you have a solid partnership agreement in place, it will detail all the events that trigger dissolution and the procedures that need to be followed. Dissolution will normally occur when:
- a partner gives notice to the other partners of his decision to leave the partnership
- a partner dies
- a partner becomes bankrupt
- partners agree to dissolve
- a court orders a dissolution (where there is a dispute that can’t be resolved)
- the specific term of the partnership project ends
- it’s illegal to carry on the partnership business
In the absence of a partnership agreement, a dissolution could cause problems for the partnership if the leaving partner wants to sell their assets.
A good partnership agreement will deal with dissolution, including giving partners the rights to dissolve a partner’s involvement in instances where they have acted inappropriately.
When it comes to termination, the agreement will include clauses that will protect the partners in the event that the agreement comes to an end. Termination provisions could deal with:
- settlement payments
- how debts and liabilities will be dealt with
- distribution and division of assets
- managing ongoing contractual obligations
If the termination is brought on by a dispute between the partners, then termination can be even more fraught than usual, this is when a comprehensive partnership agreement is useful. Having clearly defined termination provisions can help:
- prevent lengthy discussions and negotiations on termination
- save time and money
- help maintain relationships
Your partnership agreement should also contain a dispute resolution clause that helps partners resolve disputes amicably.
If the partnership is ending, then debts and liabilities need to be paid off, and any capital investment returned. Anything left should be divided between the partners in accordance with the provisions of the partnership agreement, which should state how profits are to be distributed.
The value of the business’s trade reputation is known as goodwill. Understanding and valuing goodwill is important for the partners as it represents value to the partnership. If a partner is leaving the partnership, they may be entitled to a share of the goodwill and the agreement should cover this situation and set out how the goodwill will be valued and accounted for.
Removing a Partner
If you want to remove a partner and you have a partnership agreement in place then you will need to follow the provisions of the agreement when it comes to removal. If there is no partnership agreement then you will have to rely on employment law rules relating to dismissal, which can be very complex and make it difficult to remove a partner.
There are various ways to expel a partner from a partnership including the Green Socks Clause.
It is always best to have a partnership agreement as this makes it much easier to deal with removing a partner.
A good agreement will include specific situations in which a partner can be removed.
These include breach of the agreement, bankruptcy, misconduct, dishonesty and incapacity, amongst others. The agreement will outline the process that needs to be followed to effect a removal.To get advice on how best to structure your business partnership, get in touch.