A partnership is a relationship or association between two or more persons with a view to profit. The persons may be individuals or companies. Unlike a company the partnership is not incorporated. The rights and obligations of the partnership are governed by a partnership agreement which may be made in writing, verbally or by implication. It is also governed by the Partnership Act. Net Lawman recommends a written agreement is made to avoid disputes in the future.
A partnership enters into an agreement in the name of its partners. Usually each partner is jointly liable for the obligations under the agreement.
Accounting and records
Unlike companies, partnerships do not have any special legal accounting or recording requirements. Of course it is good practise to keep proper accounting records for taxation purposes. Income and losses are allocated to each partner according to their shareholding in the partnership; therefore it is important the accounts properly record income and loss so that each partner can calculate their individual tax.
Everything in a partnership is shared in accordance with each partner's shareholding in the partnership. Each partner’s shareholding is recorded in the partnership agreement. Similarly, assets and liabilities are shared between the partners in accordance with each partner's shareholding.
Note, unlike companies, partnerships have unlimited liability. This means that if one or more of the partners are found liable for doing or failing to do something, then all the partners in the whole partnership are personally liable. In a company, shareholders' liability is limited to the extent of their shareholding, which means the most they can lose is the value of their shares. In a partnership, on the other hand, there is no limit on the potential liability of partners.
There is no legal requirement for either party to hold a certain number of shares. The amount of shares held by each partner will depend upon the agreement reached between the parties. The proportion of shares held should be recorded in the partnership agreement.
The shareholding may be a fixed amount or a percentage. The amount should take into account a possible increase or decrease in the value of the partnership business and assets. The shareholding may or may not reflect the liability or profit share of each party.
For example, a party may have contributed 50% of the assets but may be liable for 75% of any liabilities. Similarly, the party may only be entitled to 40% of the profits of the partnership business.
The partnership agreement should set out all the terms of the relationship including the following:
- Partnership shares
- Partnership assets
- Distribution of profits
- Partnership liability. How liability is to be apportioned between the partners
- Terminating the partnership/buy back of shares
- Disputes resolution
Partnerships are not taxpayers, but the individual partners must still pay tax. The income of a partnership and its losses are apportioned according to each partner's shareholding in the partnership. Each partner must include their share of the partnership income and/or loss in their own personal tax return. Capital gains and losses on partnership assets are also apportioned amongst the partners.
Terminating the partnership/buy back
There might come a time where one partner ‘wants out’. In this case, there are a number of possibilities:
- If a partnership is created for a particular purpose, then after the purpose is achieved or abandoned, the partnership dissolves
- If a partnership is created for a fixed period, then after the period is over, the partnership dissolves
- Once a partner resigns from a partnership or dies, the partnership is considered to be terminated
- If there are still partners remaining then they will be treated as partners in a new partnership
- If a partnership is engaged in unlawful activities, it will be dissolved by the law.
These are not the only ways in which a partnership terminates. Often the partnership agreement will provide for situations in which the partnership terminates.
Important elements in a partnership
Identification of the partners with the business
Like the sole trader structure, a partnership is not an entity separate from its operators. A partnership is an association of people who carry on business in common.
Unlimited personal liability of the partners
You and your partners may set limits on how much each of you can be liable for between yourselves, but legally, each participating partner's liability to creditors is unlimited. This means that all partners are collectively responsible for all business debts. In this respect, the partnership structure has greater liability than being a sole trader because as a partner you are not only liable for your own acts, but also for the acts of your partners, over which you may have little or no control.
Non transferability of partners' interest
Partners cannot transfer their ownership to someone outside the partnership unless the other partner(s) agree.
The right of each partner to take part in management
Generally, no change in the nature of your business can be made without the consent of all partners.
Is a partnership right for my business?
A partnership may be the right business structure for you if:
- You and your partner(s) have confidence in each other's abilities and compatibility as business partners
- You and your partner(s) believe in your business idea and model
- You are already a sole trader looking to grow your business through establishing a partnership
However, the detailed ownership rules, administrative structure, flexibility, limited liability and tax strategies that you can obtain through other structures such as a company or a trust may be more appropriate for your business.
What will be your liabilities as a partner?
If you are considering entering into a partnership, it is important to be aware of the following liabilities.
Joint and several liabilities
Partners are jointly and severally liable, which means that as well as having a shared liability for all of the debts of the partnership, they are also individually personally liable for all debts incurred by or in the name of the partnership.
Contractual liabilities to third parties
The Partnership Act 1891 places joint liability on all partners for the business's debts and obligations incurred during their involvement in the partnership. This means that partners can be liable for debts incurred without their knowledge or authority. If your partner contracts with a supplier, you are liable for the debt even if you didn't know about it. You, as well as the partner who incurred the debt, can even be sued individually for all of the debt.
Liability for wrongs to third parties
When a partner leaves a partnership, they are still liable for debts and obligations incurred during the time that they were in the partnership. Exceptions to this arise when there is an alternative agreement between the other partners and the people to whom the debts are owed. New partners are not liable for debts or obligations incurred before their arrival into the partnership unless they agree to be.
Liability to account
You are obliged to keep your partners properly informed. For example, if you are doing business outside of your partnership which is seen to be in competition, you are legally bound to inform your partners and may have to share any profits you make.