There is often some confusion over what a partnership is. A partnership is a formal arrangement by two or more parties to manage and operate a business and share its profits. The Partnership Act 1890 defines partnership as “persons carrying on a business in common with a view of profit.” As with all areas of law this may seem pretty straight forward, but there have been cases where it has been decided that there was a partnership, despite an individual taking no share of the profits. Partnerships can be created without even realising it and are commonly when both or all parties are registered as self-employed and there is no separate legal entity like there would be if it was a limited company.
A partnership is a contractual relationship, and it may be created orally with no formal written agreement but it is always advised that a written contract is put in place as in the absence of an agreement the implied terms of The Partnership Act 1890 will apply.
Experienced business owners will often tell you that a business partnership is similar to a personal partnership. Both relationships require clear communication between the people involved so that any misunderstandings can be avoided. Otherwise, the whole thing would just fall apart.
In business, understandings and agreements between partners should be set out in writing. For example, if there is a dispute between the partners or something happens to one of them, the people involved in the business can determine what they should do to resolve the issue. This is why all business relationships should have a written partnership agreement in place.
Limited Liability partnerships are a common structure for professionals, such as accountants, lawyers and architects. This arrangement is different from the traditional partnership under the UK Partnership Act 1890 as each partner has joint liability. In an LLP if one partner is sued for malpractice the assets of the other partners are not at risk since each partner is not responsible or liable for another partner’s misconduct or negligence.
Partnership Agreement Explained
So what is a partnership agreement? As the name suggests, a partnership agreement is an agreement that governs the workings of a business partnership. Put simply, it is a contract that sets out the terms and conditions of the relationship between the business partners. The areas it governs include:
- Ownership percentage
- Distribution of profits and losses
- Length of the partnership
- Termination of the partnership
Like when forming a limited company a shareholders’ agreement is essential, it is important that the partnership agreement is drafted at the beginning of your business partnership.
Importance of a Partnership Agreement
Some may think that a partnership agreement is not really necessary, especially if the business partners are friends or relatives. However, this is not the case as this document can in fact prevent problems from arising in the future. Here are four reasons why it is important to have a partnership agreement.
1. It avoids the implied terms of the Partnership Act 1980
There are 9 implied terms that would apply in the absence of an agreement including the distribution of profits and losses, who is involved in making management decisions and any property that has been used in the course of the business would automatically become the partnership’s property.
2. It helps define the roles and responsibilities of each partner
The agreement describes how decisions are made. It also outlines the roles and responsibilities of each partner and how these responsibilities can change in the future.
3. It helps everyone deal with changes and important issues
If any changes occur in the partnership due to personal challenges experienced by the existing partners, such as divorce, illness or death, confusion can be avoided as the remaining partner/s will know exactly what to do.
4. It helps resolve issues
Conflicts of interest, misunderstandings and disagreements between partners can be resolved quickly if a partnership agreement is in place. This document defines the measures that could be taken to ensure a quick and efficient dispute resolution.
What Should be Included in a Partnership Agreement?
The scope of your partnership agreement will ultimately depend on you and your business partner. However, as a rule, you should include the following clauses and sections.
1. Definitions
As the name suggests, this section should provide the definitions of some of the most important terms included in the agreement. This will help ensure that everyone understands the terms and provisions of the partnership agreement.
2. Partnership
This outlines the nature of the business and the name of the partnership.
3. Capital
This clause describes how the business will be funded. It also deals with financial matters, including initial costs, any investments or loans made by each partner and the percentage of ownership belonging to each partner.
4. Management and decision-making
This section outlines how the company will be run. It also stipulates how the decisions will be made within the business, who will make them and what partners can bind the company in any future agreements.
5. Accounting records and annual accounts
This section explains when and how the company’s financial records should be kept.
6. Profits and losses
As the name suggests, this clause explains how the profits and losses will be divided between the business partners.
7. Drawings
This section provides instructions on how you and your partner can withdraw money from the company funds.
8. Duties and responsibilities
This clause outlines the roles and responsibilities you and your partner must fulfil. Failure to do so may have legal ramifications.
9. Restrictions
This clause lists the activities a business partner is not allowed to engage in without the written consent of the other party. This includes lending money owned by the business, becoming a guarantor or selling shares to a third party without the other partner’s prior knowledge.
10. Dissolution
This section explains the conditions or scenarios that could lead to the dissolution or termination of the business partnership.
11. No assignment
This section states that no partner can assign or transfer the benefits provided by the partnership agreement.
12. Schedule
Usually found at the end of the partnership agreement, this clause lists the names of the partners, as well as their contributions and share of the company’s profits and losses.
Conclusion
It is not a legal requirement to draw up a written partnership agreement when setting up a business partnership. However, ensuring that there is an agreement in place can do wonders for your business. For example, it can help you settle disputes in an efficient and timely manner, and it can also help prevent uncertainties and ensure that your business is managed in an appropriate way. Many finance and business management experts agree that businesses with more than one owner should have a binding written agreement between the partners or shareholders. So, even if only two or three of you own the business, it is important that you all consider signing a partnership agreement.
If you need any assistance drafting a partnership agreement, our team at BEB will be happy to help. We can draw up a partnership or shareholders’ agreement to suit your exact requirements.