Episode 3 –
In our last article in the series “Choosing the right legal entity for your business (link)” we looked at the sole proprietorship [link] option. Let’s move on to the partnership option, where a group of business owners replaces the sole owner/trader.
Firstly, what exactly is a partnership?
We talk loosely about our “partners” in various contexts, but it is important to understand how the law views the concept in a strictly business situation. In broad terms a partnership is an association of between 2 to 20 people/companies/trusts who agree to pool resources (such as money, property, services, skills etc – whatever is agreed upon) and to operate a jointly-owned business, trade or profession for profit. Partnership assets are jointly owned by the partners and profits are split between them as agreed.
A quick note on the different types of partnership
In this article we talk only about the most common form of partnership – the “ordinary” partnership. In specific circumstances you may also want to consider an “anonymous” partnership (where one or more of the partners are “sleeping partners”) or an en commandite or “limited” partnership. They differ from “ordinary” partnerships in several important respects so take specific legal advice if you are thinking of using them.
We’ll look at the “universal partnership” concept in a future article (it’s normally relevant in cases of cohabitation by unmarried couples).
6 advantages of partnerships…..
- It’s relatively easy to set up and operate a partnership in the sense that there’s no need for formal registration as there is with a company or trust. Just be sure to have a comprehensive written partnership agreement in place. Although this is not a legal requirement, and although it adds an element of cost and delay, our law reports are full of bitter and costly partnership disputes resulting from the uncertainties that will always attend a verbal or poorly-drafted agreement. Good intentions and a handshake mean nothing when friction arises.
- You have no statutory audit requirements and your administrative burden is low compared to, for example, running a company.
- You are taxed at personal rates, which can sometimes (not always – see below) be to your advantage.
- A partner often gives you access to another source of funding and/or assets for the business.
- Most partners also bring new skills to the business.
- It’s not nearly as lonely as being a sole trader – you have partners to share both the workload and the stresses and strains of management and decision-making. Just make sure you also share a common vision for the business, or friction is inevitable.
….. and 6 disadvantages
- Loss of control – you now have only part control and ownership of the business, and decisions can take longer than if you were on your own.
- Any partner can bind the partnership contractually so it is essential that you find partners whom you can trust implicitly to act both honestly and wisely in relation to the partnership and its business.
- As a partnership isn’t a separate legal entity, you are personally liable for all the debts and obligations of the partnership business. If the partnership can’t pay its debts, creditors can and will sue you for them. And if the partnership is sequestrated, your personal estate will simultaneously also be sequestrated unless you provide security for all partnership debts. As with sole proprietorship, sleepless nights await you if any important assets (like your house) are in your name. Think about protecting your assets!
- When any partner dies, leaves the partnership or goes insolvent, or when a new partner joins, the partnership automatically ends. Once again you are then personally liable for any shortfalls in the partnership’s ability to pay its debts.
- If you end up paying more than your pro-rata share of any partnership shortfalls, your claim against the other partners (or their estates) will be worthless unless they have enough net assets to pay you.
- Tax and estate planning – as with sole proprietorship, being taxed at your personal income tax rate may be a plus in some cases, but in others you will benefit far more from a tax-efficient structure incorporating one or more corporate entities or trusts as well.
What about “Joint Ventures”?
Before you agree on a joint venture (“JV”) with another individual or business, be careful. Although a JV normally applies only to a single transaction, it could well amount to a partnership, no matter what title or description you give it. And as we saw above, partnerships have many pitfalls for the unwary – rather put your JV into a separate entity or have your lawyer draw up a JV agreement giving you some form of liability protection.
Watch out incidentally for “inadvertent” partnerships – as a partnership can be formed verbally or even tacitly (implied from conduct), you could find yourself establishing a partnership by mistake! Another reason to have everything recorded in a full contract.
Remember to take full professional advice on the legal and tax implications of using each type of entity before choosing.