- A partnership is a legal structure through which two or more people can operate a business as partners.
- A partnership structure is often used by professional service businesses such as law, accounting, management or architectural firms.
- A partnership agreement is the main document needed to operate a business under a partnership structure. It sets out the relationship between partners and determines how the partnership will operate.
Benefits of a Partnership Structure
Choosing the right structure for your particular business is a crucial step in ensuring its success. Each structure has its own legal, commercial and financial considerations, including different startup and registration fees, ongoing costs, legal documentation and tax benefits.
The partnership structure falls somewhere between sole trader, the simplest structure, and the more complex company structure. Operating a business as a partnership may be the right choice if undertaking the business as an individual would be too difficult and you’re seeking to grow the business by raising capital (which can be very difficult for a sole trader), but do not wish to incorporate.
There are three different kinds of partnerships; general, limited, and limited liability.
A general partnership involves two or more individuals carrying on a business, sharing equal rights and responsibilities about the business operations and management. This also means that each partner has unlimited personal liability for the actions and debts of the other partners and the business as a whole.
A limited partnership has one general partner who assumes the full personal liability attached to a general partnership structure, while the other partners can restrict their personal liability to the amount of their share or investment in the business.
A limited liability partnership (LLP) limits individual responsibility for wrongful acts of other partners and personal liability for the business’ debts. This particular partnership structure is usually used for the larger professional service businesses and added personal asset protection. This structure, however, does not protect partners from liability for their malpractice.
Each of the partnership structures attracts tax advantages, as partnership profits pass through the business directly to the partners, who include the gains on their individual tax returns at a much lower rate than personal income. General partnerships, limited partnerships, and LLPs are all taxed in the same way.
The table below briefly illustrates how the general partnership structure differs from the sole trader and company structure.
|Business Structure||Sole Trader||Partnership||Company|
|Expensive to register||No||No||Yes|
|Difficult to set up||No||No||Yes|
|Complete control over decision-making||Yes||No||No|
|Easy to raise capital||No||Yes||Yes|
|Can I retain all profits made?||Yes||No||No|
Advantages of a Partnership
Setting up a partnership is inexpensive in comparison to incorporation and has fewer legal requirements. There is little external regulation by government bodies such as the Australian Securities and Investment Commission (ASIC) and less administrative burdens; partnerships are not required to publish their annual financial records as companies do.
Operating a business alone can pile on a lot of pressure while in a partnership responsibilities and management duties are shared. Each partner will bring to the table their expertise, experience, and brainpower, offering different perspectives and bringing new, fresh ideas to the business, increasing its chances of success. They will also bring their own capital, adding to the businesses available resources, which can be particularly helpful when trying to get the business off the ground.
It is also much easier to grow a business as a partnership as opposed to a sole trader. Investors and creditors are far more likely to go into business with a partnership than with an individual. As time goes by you can also bring on new partners, and the offer of partnership can be a great incentive to employees.
Disadvantages of a Partnership
The disadvantage of a partnership is the lack of limited liability that attaches to the company structure. In a partnership, each partner is exposed to personal liability on behalf of each of the other partners. What this means is that if the business, or even an individual partner, is sued or goes into debt, all of the partners are jointly liable and may be forced to pay the defaulting partner’s share.
As a sole trader, you make the business decisions yourself, whereas in a partnership the authority over management and operation of the business is divided. There can sometimes be disharmony amongst partners and personality conflicts can disrupt the smooth sailing of the business. If one partner leaves, the other partners may be required to buy him or her out and value the partnership assets in the process.
Alternatively if a partner dies and this is not provided for in the partnership agreement, the business is dissolved. This lack of natural continuity in partnerships is why it is very important to choose carefully who you go into business with, and have a well drafted, comprehensive partnership agreement that accommodates for the possibility of disputes between partners and accounts for the survival of the business in the event of a partner’s death.
- In choosing whether a partnership structure is best for your business and goals for growth, you must consider your financial position and that of your partners, the issue of taking on personal liability, insurance and the tax advantages.
- Relationships between partners must be accounted for. You do not want to go into business with someone you may easily disagree with, or to rely on the strength of existing relationships. Circumstances change and in the context of business things can easily get messy. Provide for these situations in the partnership agreement by getting independent legal advice and having it drafted by an experienced contract lawyer.
- Restructuring the business – it is relatively easy to change partnership structures from general to limited liability, for instance where the business has grown, and you wish to protect yourself from personal liability.
The Partnership Agreement
The terms of a partnership should be set out in the Partnership Agreement, which is the defining contractual document that will determine how the partnership will operate. Like any other contract it can be verbal or written – the partnership structure begins as soon as partners begin business operations together – however, it is highly recommended that your partnership agreement is in writing and signed by all parties involved.
A Partnership Agreement should clearly set out the expectations, rights and obligations of each partner. Having a well-drafted Partnership Agreement will reduce the possibility of disputes arising at a later stage. A good contract lawyer should draft the Partnership Agreement for you, or at least review it and bring to your attention circumstances or scenarios that you may not have considered. This will help create a far more comprehensive Partnership Agreement, which is important for risk management and could potentially save you money and stress down the track. Each individual partner should seek independent legal advice so as to ensure that everyone is entering into the agreement on fair and equitable terms.
The Partnership Agreement should set out:
- the name of the partnership;
- the establishment of the partnership;
- where the partnership will conduct its business;
- who is to manage the partnership;
- the role of each of the partners;
- how new partners are appointed;
- how partners retire;
- financial contributions;
- distribution of profits and assets;
- insurance requirements;
- whether the partners are prohibited from borrowing from the business;
- whether the partners are to indemnify the other partners for any negligent act or
- what types of matters require unanimous decisions and what types of matters can be
- decided on partners acting alone (for example, the limit of money each partner can
- draw upon);
- how partnership disputes are to be resolved;
- how the partnership can be dissolved; and
- what happens in the event of a deadlock between partners?
Frequently Asked Questions about Partnerships
Q: Can I draft the Partnership Agreement myself?
A: Yes you can, but it is strongly advised that you seek legal advice to ensure that you have provided for unforeseen circumstances such as a dispute or death of a partner.
Q: Can I change my business structure from partnership to the company?
A: Yes, but you first need to cancel your ABN (Australian Business Number) and apply for a new one under the new structure. You have to be aware of the various legal and financial implications this will have on your business and clients.
How can LegalVision help me?
LegalVision provides businesses and individuals with tailored online legal advice, including drafting and reviewing Partnership Agreements. Get in touch by calling 1300 544 755.