What is the difference between partnership agreements and shareholder agreements? It primarily depends on the structure and type of business structure that the parties in question are associated with and have formed or considering forming. Neither agreement is mandatory but absolutely recommended.
It’s common for business owners to casually refer to their venture as a “partnership,” but in reality, the legal structure may be something entirely different. For example:
- A business operating as a private limited company with multiple shareholders/owners might be called a partnership by its founders, but legally it’s a company.
- Similarly, a sole trader taking on another person’s involvement might be assumed to be forming a partnership, when in fact no formal partnership exists unless certain criteria is met. They could just be a sub-contractor.
Using the wrong terminology can lead to confusion over liability, taxation, and finding the wrong template on the internet or using AI. That’s why it’s crucial to clarify your business structure early and put the right agreement in place, be it a partnership agreement or a shareholder agreement, We can help.
When starting a business in the UK with other individuals, one of the crucial decisions you’ll need to make is choosing the appropriate business structure. Two common options are forming a partnership or forming a limited company. Both options come with its own set of advantages and disadvantages, and the choice will depend on various factors, including business goals, liability concerns, tax implications, and management preferences. A good accountant can advise you on the best structure for you.
What is a Partnership Agreement?
A partnership agreement is used when two or more individuals are running a business in common with a view to make profit. A partnership can exist in law, whether that was the intention or not and would be known as a general or ordinary partnership. With this in mind, its absolutely crucial that a partnership agreement is drafted. A partnership agreement overrides the terms implied by Partnership Act 1890 meaning in the absence of one you run the risk of many problems occurring as detailed more here (back link to PA blog).
Partnerships can be a simple and cost-effective way to start a business, making them particularly attractive to small businesses especially since the risk is shared. However, with the lack of corporate structure, there can be limitations with growth and attracting investment.
As a partnership, you can also consider a limited partnership (LP) (where partners limit their liability) or a limited liability partnership (LLP) (which is a separate entity). LPs are not a popular idea due to the unlimited liability risk to one partner and LLPs are mostly commonly used in professional businesses like law firms, accounting firms, medical practices, and wealth management companies.
Although LLPs share some common characteristics with ordinary partnerships, there are some significant differences. From a legal standpoint, ordinary partnerships in the UK are governed under the Partnerships Act 1890, whereas LLPs are governed under Limited Liability Partnership Act 2000. Partners in an ordinary partnership are liable for debts and share the responsibility for any losses the business makes, whilst an LLP is a separate legal entity and has its own rights and obligations. Whichever partnership is decided or formed, a private agreement known as a partnership agreement is crucial to protect the partners and the business.
What is a Shareholder Agreement?
A shareholder agreement is used in a private limited company where the business is owned by more than one shareholder.
Unlike an ordinary partnership or indeed trading as a sole trader, a limited company has a separate legal identity meaning your personal assets are protected if the business has financial difficulties. Limited companies face extensive legal and regulatory requirements which can consume time, money, and potentially mean hiring professionals which would increase operational costs. Limited companies also have to disclose certain information to the public which can impact the privacy of the company’s owners and major decisions often require approval from directors and shareholders, which can slow down business.
However, on the flip side, shareholders are not personally responsible for the company’s debts, which shields their personal assets in case of business insolvency or legal issues. Limited companies also appear more established and credible, which can be an advantage when dealing with clients, suppliers, and investors
Whilst all limited companies are required to have an articles of association, which lays out the rules directors and shareholders must follow when running their companies, “model” articles of association are the standard default articles a company can use and they are prescribed by the Companies Act 2006. Whilst these articles can be amended to suit your needs, it is a public document that can be viewed by anyone and also follows strict rules on what can be included.
A shareholder agreement keeps certain things more private and can include anything the shareholders agree on. Further, the articles of association create a legal duty between the actual business and its shareholders, whilst shareholder agreements create legal contractual duties between only the shareholders of the agreement.
Now that you understand what the difference is between partnership agreements and shareholder agreements, it’s essential to know which document is the right one for your business. To put it simply, which agreement you have entirely depends on what business structure has been formed. Nevertheless, both types of agreement should be put in place as they are crucial for defining the relationships between the people involved in the business and can help prevent misunderstandings and disputes in the future.
Here’s a clear comparison table summarising the key differences between Partnership Agreements and Shareholder Agreements based on your content:
| Feature | Partnership Agreement | Shareholder Agreement |
| Applicable Business Structure | Partnerships (general, limited, or LLP) | Private limited companies |
| Best For | Small businesses, professional firms (LLPs), businesses where partners want close control | Businesses planning multiple shareholders, looking for limited liability, external investment, or growth |
| Legal Status | Partnerships do not have a separate legal identity (except for LLPs) | Limited companies are separate legal entities |
| Liability | Partners can be personally liable for business debts (except in LLPs or limited partnerships) | Shareholders are not personally liable for company debts; |
| Governing Legislation | Partnership Act 1890 (ordinary partnerships) or Limited Liability Partnerships Act 2000 (LLPs) | Companies Act 2006 |
| Purpose | Defines how partners operate, share profits, handle losses, and make decisions | Defines rights, responsibilities, and obligations of shareholders; complements Articles of Association |
| Privacy | Agreement is private between partners | Agreement is private between shareholders (Articles of Association are public) |
| Growth & Investment | May be harder to raise investment; limited structure | Easier to attract investment; limited company structure appears more credible |
| Decision-Making | Shared by partners as per agreement | Decisions often require director and shareholder approval; agreement can set special rules |
FAQs
- Can I switch from a partnership to a limited company later?
Yes. Many businesses start as partnerships due to their simplicity and lower costs, then convert to a limited company as they grow or seek investment.
When doing so:- You’ll need to transfer business assets, contracts, and liabilities to the new company.
- Shareholders (often the former partners) will need a shareholder agreement to govern their rights in the new company.
- A professional accountant can help ensure the transition is tax-efficient and legally compliant.
- What if I’m a sole trader bringing on a partner?
If you’re a sole trader and plan to take on a partner:
- Without registering as a limited company this would form a partnership.
- A partnership agreement is strongly recommended to clarify profit sharing, roles, decision-making, and exit terms.
- Without a formal agreement, the terms will default to the Partnership Act 1890, which may not reflect your intentions and can lead to disputes.
- Do I need both agreements?
No.- Partnership → Partnership agreement only.
- Limited company → Shareholder agreement (in addition to Articles of Association).
- How much does each cost to draft properly?
- The cost varies depending on complexity however not by much
- Both agreements start from £599 + VAT with certain factors affecting cost: such as number of partners/shareholders, complexity of profit-sharing or exit clauses, and whether spe
Get in touch with us today at 01604 217365 or info@bebconsultancy.co.uk in order to discuss drafting a partnership or shareholders agreement tailored to your business.