One advantage of setting up a business as a partnership is that, unlike a company, there is no need to register the business.
In fact there are very few formalities, which is one reason why it is sensible to have a written partnership agreement that sets out the basic rules between the partners for running the business.
The main difference between a partnership and a limited company is that a partnership does not have a separate legal personality apart from its members in a way that a limited company does. (The situation is different for a limited liability partnership, but that is more like a company and has to be registered at Companies House).
So the partners are jointly and severally liable for the obligations of the partnership i.e. each partner can be sued for the full amount of any liability of the partnership. There is no limit on liability
Also, the partners are taxed on an individual basis, by reference to their share of the profits each year.
The law governing partnerships goes right back to 1890 and it is a lot easier to read than today’s statutes. But while it has stood the test of time, the Partnership Act does not always deal with issues as the partners want to deal with them.
Why You Need a Partnership Agreement
Without an agreement, there can be uncertainties as to the relationship between the partners and how the partnership should be run. For example, in the absence of a partnership agreement, on the death of a partner, the partnership has to be dissolved. This might not be in the interests of the surviving partners who wish to keep the business going.
Similarly, in the absence of any agreement to the contrary, the partners have the right to share equally in the capital and profits of the business.
What specific terms should you consider for your partnership?
Here are some of the basics to cover in the agreement that all the partners need to sign.
- Name, Business, Start Date
When starting the business you need to agree on the name and start date of the business and the annual accounting year. Also, you need to agree on the scope of the business and write all these details down.
- Capital & Profits
How much money or other assets – e.g. equipment or knowhow – will each partner put into the business to get it going? Also, you should specify the profit shares – otherwise all profits are divided equally.
And if there are loans to the business form any of the partners, these need to be documented.
In most modern firms, each partner will draw an agreed amount out of the income each month, rather like a salary, and his profit share will then be adjusted at the end of the year. But usually the agreement will say that if there is not enough money in the bank, drawings cannot be taken.
- Management & decision-making
There should be an arrangement for holding regular meetings of the partners where the business will be reviewed and decisions taken. In a small firm this may mean that all the partners need to agree before any decision can be implemented. But often there will be a majority vote on routine matters and unanimity reserved for the important issues – introducing a new partner, raising a loan or buying property etc.
If the partnership decides to delegate some decisions to an individual partner, this should be recorded – either in a partnership decision or in the agreement. And it is advisable to require that partner to report to partnership meetings, so that all the partners know what is going on
The procedure for meetings, quorum, who will act as chairman, circulation of minutes etc. can usefully be covered in the agreement.
Preparation of regular management accounts is another important matter as well as having a firm of accountants appointed to prepare the annual accounts of the business.
- Permitted partnership expenses
Petty arguments over what expenses can be charged up to the firm are best avoided, so spell out the main points in the agreement and decide any changes at a formal partners meeting. Mobile phones, laptops, car expenses etc. can all be covered.
As partners are not employees of the business they do not have any statutory rights so you need to set out the holiday entitlement of the partners, as well as maternity leave etc.
- Retirement or death of a partner
With current legislation a fixed retirement age can be problematic, as the partnership may face a claim for age discrimination. But you need to have a reasonable notice period if anyone wants to leave the partnership – maybe six months or longer, preferably to take effect at the end of the financial year.
If a partner dies, the agreement should say what happens to their share – it will probably need to be paid for by the surviving partners in proportion to their shares in the business. This also applies when a partner retires.
Accounts will need to be prepared by the firm’s accountants when a partner retires, and the firm may want to retain enough to cover any tax liability that is anticipated before paying the retired partner’s final profit share.
Repayment of capital to a partner who retires or dies may be spread over a period
Hopefully there will be no need to expel a partner for misconduct but you should have a clause to deal with this possibility. This will also specify how any money due to her will be repaid – probably only after any losses she caused the firm have been quantified and recovered.
- Restrictions on partners
Serious harm can be done to a business if one of the partners, without any consultation, makes commitments to third parties, and you should include a clause designed to avoid those risks. In addition, any partner who fails to comply should be required to indemnify the others so that they do not suffer loss.
Restrictions on a partner having an interest in any business that competes with the partnership may also be required, and this can be particularly important if a partner leaves, to prevent him/her from taking business away. Departing partners should also be prevented from poaching staff.
- Other clauses are needed to deal with issues such as confidentiality and disputes.
ContractStore has three forms of partnership agreement – for partnerships with two, three or more than three partners. We also offer partnership agreements for use in India