A partnership is a group or association of two or more people who carry on a business and distribute income or losses among themselves. Those people can be companies, individuals or trusts.
Some of the advantages of a partnership involve direct distributions of profits, shared liabilities and contributions to capital. Some of the disadvantages include joint and (in some states) several liability for partnership debts.
There can be various tax benefits to operating on the basis of a partnership. These are best discussed with your accountant or tax advisor.
Do you need a written partnership agreement?
Partnerships can operate without a written partnership agreement. In that case, however, your partnership will be governed by the rules set out in the relevant legislation.
As partnerships are governed by state law, while the laws affecting partnerships may be similar from state to state, they do contain a number of important differences between them. In New South Wales, the relevant legislation is the Partnership Act 1892 (NSW).
If you do not want the general provisions of the Partnership Act to apply to your partnership, and would like to make provisions specific to your partnership, you will need a written partnership agreement.
A written partnership agreement may be important for tax purposes, especially where profit and loss is not distributed equally among the partners.
It is generally a good idea to have a partnership agreement as it helps to pre-empt any misunderstandings about what each partner is expected to bring to the partnership, and what each partner is entitled to receive from the partnership’s income.
It may be a risk in the stress or excitement of starting a new venture to fail to plan ahead, while the partners are on good terms, in the event of any future disputes. This is of particular importance in partnerships as you could potentially find yourself liable for the actions of another partner.
A written partnership agreement can clarify these issues.
What kinds of matters are addressed in a partnership agreement?
Partnership agreements should be tailored to the specific business being undertaken. As such, there is no exhaustive list of matters which should be addressed in partnership agreements. However, there are common issues which you may wish to address, whatever the partnership:
Contributions by partners and ownership
Often the contributions to the partnership dictate the percentage of ownership – but this is not necessarily the case. That is something that should be discussed and agreed upon in advance.
Partners can put into the agreement what each partner is going to contribute to the business. This may be in the form of capital to cover start-up costs, equipment, services, property.
The agreement should set out what work obligations are expected from each of the partners. It can also set out whether one or more partners take more of a money role, while other(s) take on technical work, or the day-to-day operation of the business.
The agreement can also set out what happens if the start-up capital is not enough to bring the business into profit, and the business requires more money. It can set out whether the partners seek external investment or have the owners contribute more money themselves.
Division of profit and loss
Profit and loss can be divided as per the percentage of ownership, but again, a written partnership agreement can change this and provide for a more detailed outline of profit and loss entitlements and responsibilities.
The partnership agreement can not only indicate how money will be allocated among the owners, but when. It is important to consider when profit can be withdrawn from the business so that it is clear among the partners how regular the income can be.
Without a partnership agreement, it will be assumed that profits will be distributed in accordance with the share of each partner – this is what the Partnership Act provides. However, a written partnership can make provision for one or more partners to be paid a “salary”, which may have tax advantages.
Other important questions addressed in a partnership agreement might be:
- If one partner contributes more time or money to the business, will they be entitled to a greater share of the profits?
- How will the business losses be managed?
- What processes are to be followed if a partner makes a loan to the partnership?
- When will partners be repaid for any investments put in?
Length of partnership
Partnerships are typically established to operate without a specific end-date in mind.
However, in a partnership agreement, partners can plan to dissolve the business or end after a certain period of time or upon reaching a certain objective.
Decision-making and authority
Lack of adequate decision-making provisions is one of the most common causes for conflict in partnerships.
The partnership agreement can set out a clear decision-making process, as in the establishment of a voting system or other methods for enforcing checks and balances between the partners.
Decision-making processes can be different for different subject areas. It may be that the partners require some decisions to be made unanimously, others to be made by majority, and still others by single partners.
As partners may find themselves liable for a contract or debt entered into by another, it is important to give careful consideration to these matters. Having this set out in advance reduces the risk of misunderstanding and dispute.
If there is a dispute, a partnership agreement can provide instruction to the partners as to how to resolve those disputes.
To prevent the cost or unnecessary escalation into litigation, clauses may be put into the agreement requiring the partners to attend mediation and attempt all avenues of dispute resolution prior to seeking court intervention.
While it may be discomforting to discuss at the start of a new partnership, the partners may wish to include clauses outlining what procedures there will be for removing a partner who is not performing well.
Withdrawal or death
Partnership agreements should protect the partners against the risks of one of the partners passing away, and also provide an avenue for withdrawal by the partners.
Again, there may be advantages to providing an agreement in writing which does not simply leave the partners to the general provisions of the Partnership Act. The Partnership Act states that a partnership ends upon the death of one of the parties.
If you want to continue the partnership, you will need to set up a new ABN, TFN, new bank accounts. In a partnership agreement, partners can agree that a partnership continues with, for example, the estate of the deceased partner.
The partnership agreement could contemplate what buying or selling arrangement there is upon the withdrawal or death of a partner and the valuation process to determine the price of their interest.
There may be references to the partners holding life insurance policies designating the other partners as beneficiaries, or other terms referring to trusts or wills.
It is important to consider not only who may inherit your interest in a company, but whether you would be prepared to continue the business on the basis of sharing decision-making power with a deceased partner’s spouse, family members or friends.
The above matters are simply a few of the considerations to be made in the preparation of a partnership agreement. Other matters which might be taken into account include but are not limited to partnership premises, balance sheets, accounts and record-keeping practices, nomination of accountant, nomination of bank, partners’ meetings, sale of business, winding up, dissolution, appointment of a receiver.
These are matters about which it is prudent to consult both a lawyer and a tax advisor. If you require any advice as to the legal aspects of setting up a partnership, please do not hesitate to contact our offices.