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In a partnership, a group of like-minded professionals pool their resources in the pursuit of making a profit. Although the intention is that the partnership will deliver a surplus each year, there may be years where the business incurs a loss. Consequently, the net income is divided among each partner based on their contribution percentage unless agreed otherwise in the partnership agreement. If you are considering setting up a partnership, one of your key considerations will be how to distribute the proceeds of our labour; at what times, and in what sums? This article will explore key considerations when dividing profits and losses for your partnership.
What Goes in My Partnership Agreement?
As with any contract, you can include whatever terms you like in your written partnership agreement. However, it is essential to make your agreement comprehensive to protect partners in worst-case scenarios. Such scenarios include where your business fails or one partner incurs significant debt – what effect will this have on other partners?
Accordingly, it is best practice to document the framework of the partnership in your agreement. This framework should cover all duties and obligations of each partner. Likewise, it should have details concerning the input, outlay and disbursement of partnership income. You will also want to cover the partnership’s length of the term (if any), and ways to end it. Other considerations include:
- decision-making processes;
- dispute resolution methods; and
- entry and exit processes.
Drawing of Profits
It is difficult to determine each partner’s share before the business’ financial accounts are finalised for the financial year. Consequently, it is common for partners to receive partnership ‘drawings’ throughout a financial year based on their share of anticipated partnership profit (or loss).
If your venture is profitable, the drawings may be modest or significant. Again, it is a matter for the partners themselves and an issue you must decide on per the partnership agreement. If your agreement is silent on this issue, you might draw profits at each partner’s discretion.
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Responsibility for Losses
Notably, each partner is jointly and severally liable for 100% of partnership debts.
Given the practical effect of joint and several liability, it is essential to know and trust your business partners before entering into a partnership together.
Consequently, your responsibility for other partners’ losses may guide your willingness to facilitate large drawings throughout the financial year. It would be unwise to allow substantial drawings where the group is lacking confidence in its ability to return a profit. If your partnership suffers a loss, each partner should cover this amount through their respective shares (unless the partnership agreement says otherwise). However, suppose a partner is personally insolvent and unable to meet their obligations to the partnership’s creditors. In that case, the other partners must proportionately meet the losses.
When you are ready to sell your business and begin the next chapter, it is important to understand the moving parts that will impact a successful sale.
This How to Sell Your Business Guide covers all the essential topics you need to know about selling your business.
Key Takeaways
Partnership structures allow for management flexibility in distributing profits between partners. Your partnership agreement will be instrumental in outlining each partner’s duties and obligations, and how profits and losses are to be divided. You might decide to distribute profits early or at the end of a financial year. Unfortunately, if a partner cannot meet their debt obligations, the other partners must cover these losses.
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Frequently Asked Questions
A partnership agreement is a contract between people who enter business together with the intention of making a profit – otherwise known as a partnership. This agreement should specify each partner’s duties and responsibilities. It should also detail how profits and losses should be divided among the partners.
All partners in a partnership have joint and several liability. This means that each person is responsible for 100% of the partnership debts and the debts that other partners incur.
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