What You Need to Know about Partnership Agreements

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.

  • Drawings

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.

  •  Accounts

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.

  • Holidays

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

  • Expulsion

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.

Related Downloads:

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

Do You Need a Partnership Agreement?

If you are setting up a business, you may be wondering if you should have a Partnership Agreement, and what it would include.

The answer to this is that without it, 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. Unless there are only two partners, this might not be in the interests of the surviving partners who wish to keep the partnership 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.

Problems which can be encountered with the general law can be avoided by a properly drafted partnership Agreement, which can set out clear rules concerning such matters as capital and profit shares, drawings on account of profit, management and decision making, permitted partnership expenses, retirement and expulsion or death of a partner (and the financial consequences of retirement, death or expulsion).

Definition of Partnership

Under the English Partnership Act 1890 (“PA”) partnership is defined as ‘the relation that subsists between persons carrying on a business in common with a view to profit’.

Formalities

There are no specific legal requirements that govern the formation of a partnership. The PA governs the relationship unless there is a partnership agreement.

Partnership is a private matter and there is no public register that contains information concerning partnerships. (This is not true of limited liability partnerships which were introduced in 2002 in the UK).

Legal Status of Partnerships

A partnership does not have a separate legal personality apart from its members in a way that a limited company does. As a consequence, 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.

Duties of Partners

These arise from the partnership agreement, where there is one. In addition, partners are agents of the firm and their other partners. They also have a fiduciary relationship to each other – e.g. a duty to account and disclose information concerning their activities in relation to the partnership.

Authority of Partners

Each partner has the power to bind his partners and make them liable on business transactions which are carried out in the name of the partnership. (This power can be limited internally but if the internal agreement is breached, the partnership might still have a liability to a third party who entered into a contract in the belief that he was contracting with the partnership).

Partnership Contracts

Partnership Agreement for Two Partners

Partnership Agreement for Three Partners

Partnership Agreement for Four or Five Partners

5 Partnership Considerations to Consider

There are times when it’s best to go solo and others when you need a team effort to survive. When you’re part of a team, you need to know how to be a good team player, since a team works best when each of the players plays to his strength and complements the strengths of his teammates. When it comes to business partnerships, you’re on a sticky wicket because there are huge sums of money and large amounts of efforts involved. In order to establish a partnership that stands the test of time, you need to consider the following aspects:

  • The best partners complement each other: The most compatible partners are those who have the same goal and different strengths and expertise in various areas that are needed to achieve the goal. It’s important that your vision for the company be the same – if one person wants to run your organization as a social enterprise while the other wants to rake in the profits, you’re going to be pulling one horse in two different directions.
  • Clear cut responsibilities help avoid the blame game: A partnership in which clear cut responsibilities are defined help pinpoint the blame when something does go wrong instead of each blaming the other for the fiasco. It also paves the way for proactive measures to be taken so that the problem can be rectified.
  • Money matters destroy even the strongest of friendships: If you’re going into partnership with a friend or a relative, be warned that money is stronger than blood or friendship. If the partnership does not survive, then you can expect your personal relationship to be strained and affected too, unless both of you are really mature and are able to separate the business aspect of your relationship from the personal side.
  • It’s best to have a written agreement and an exit strategy: Even the best of friends can turn into the worst of enemies, so don’t depend on mere words, even though they were spoken in good faith, to keep your partnership secure. Draw up a written agreement that delineates each of your responsibilities, profit sharing arrangements, and how your assets will be split in case you decide to call it quits.
  • Limiting the amount of liability helps in times of trouble: A limited partnership helps you safeguard yourself in case your partner uses your common business to promise things that he or she is not allowed to. It limits your liability in the damage suit that may follow.

ContractStore has several documents to help you set up a solid basis for your partnership, including
A148 Partnership Agreement
A107 Shareholders Agreement.
A complete range of partnership documents is available at http://www.contractstore.com/partnership-and-shareholder-agreements

You can read here a case study about ContractStore customer Luke Hutchison of Southern Solar, who set up his business partnership using one of our documents.