What is a Partnership Agreement?
There is no legal requirement in law for partners who are carrying on a business together to have a Partnership Agreement. Having a Partnership Agreement is a bit like making a Will…….. while most people know that it is important to make one, it often gets left on the to-do list and the business carries on without the protection that a Partnership Agreement provides. A Partnership Agreement is a good way of setting out what will happen between the business owners in various ‘what if’ scenarios that naturally occur in the life of a business.
Without a Partnership Agreement, a business partner trying to work out his/her rights will have to look up the Partnership Act 1890 – which is one of the oldest laws still in common use (which usually means having to consult a business solicitor [aka: cost, hassle]). A Partnership Agreement can reduce the possibility of expensive and acrimonious disputes in the future.
A partnership agreement does not need to be registered anywhere once it has been signed by the partners. It is private to the business partners.
How is a Limited Liability Partnership (LLP) different to a common partnership?
LLPs have to be officially documented and registered at Companies House – in the same way as a limited company, but unlike a common partnership, which is not registered with Companies House.
Limited Liability Partnerships are a popular business model for offering the benefit of reduced personal liability for the debts of the business. Another key advantage is that a Limited Liability Partnerships has its own legal status – which means that the LLP can enter into a lease in its own name……. whereas a common partnership does not have the legal status to enter into a lease (or any other contract for that matter), and it will always be the partners that are named as parties to the lease.
When it comes to how the businesses are taxed, a Limited Liability Partnerships is like a common partnership, and not like a limited company. For example: the profits made by the LLP are split between the members, and the responsibility for paying tax therefore falls on the members and not the LLP itself – i.e. the members pay their own income tax on their own share of the profits. In a limited company it is the company itself that pays (corporation tax) tax on its profits, before they are split between the shareholders.
Commencement & Duration
A Partnership Agreement is a bit like setting out the “rules of the game”. The Agreement will state when the rules start from and what events will cause a termination or finish for the partnership. A partnership can be perpetual or for a specific term length.
The Partnership Agreement can recognise any personal loans that are made to start the partnership by the partners and it can specify how and when those loans will be repaid, and if interest is payable, and what will happen if the business needs more money?
Property will be held by the partners individually on behalf of the partnership – as the partnership is not capable of taking a lease or buying a property in its own name. The partnership agreement can outline how partnership property is dealt with if one of the partners dies/leaves.
Profits & Losses
The partnership agreement will outline how the profits are to be split between the partners, but also how losses are to be accounted for by the partners.
In practice, however, it is convenient to separate the amount invested by the partner (the capital account) from the amount they have earned through the trading activities of the partnership (the current account).
When will the partners be able to take money out of the business? A drawing is generally a cash distribution on a regular reoccurring basis similar to a salary, without any taxes withheld. It’s considered an advance payment of profits from the partnership business to the partners. As partners are the owners of the business, any amounts that are paid to them under the partnership agreement are part of their share of the profit. Charging interest on drawings is a means of discouraging partners from withdrawing excessive amounts from the business.
Roles and responsibilities of Partners
This section is very important and should specify exactly what each partner is expected to do. The roles and responsibilities will vary depending on the partnership but you need to think very carefully about all the different aspects and what needs to be done in relation to them.
Meetings & Voting
Consider how you will make decisions, especially in those cases when it’s an important topic and there is no consensus. If it is decided that major decisions must to be unanimous, then consider that if agreement cannot be reached then the partnership will not be able to move forward. Therefore, you need to establish a decision-making process in advance so your business operations can move along smoothly.
Joining or Leaving the Partnership
When a new partner is admitted to the partnership, the new partners effectively buy the assets of the old partnership from the old partners. The admission of a new partner will also mean that the profit/loss sharing ratio will change.
Clarify what happens in case of a violation of the partnership agreement or the statutes by a partner. If such a breach occurs in bad faith, the penalty is usually the immediate and total return of the infringing partner’s partnership share. The purchase price can be fixed by an expert or through another agreement between the parties.
What happens if you and your partners reach a point where you can’t agree? Instead, include a mediation clause in your partnership agreement which will provide a procedure by which you can resolve major conflicts.