Business Partnerships – What you should know

What is a partnership?

A partnership is a business structure where two or more people enter into a relationship in order to carry on a business, with the mutual intention to make a profit through their joint endeavours.  Partnerships are regulated on a State by State basis[1] however, the Corporations Act 2001 (Cth) places some limits on the number of persons who can set up a partnership.[2]  Often, a partnership structure is used for smaller and less sophisticated enterprises which do not need the complication, expense and compliance issues which are required for a corporate structure.

Types of partnerships

There are three types of partnerships, these being general, limited and incorporated partnerships.  In general partnerships – which is by far the most common form, all partners are equally responsible for the management of the business and each has unlimited personal liability for all of the debts and obligations of the enterprise.  Limited partnerships consist of both general partners whose liability is unlimited, and limited liability partners whose liability is limited by their investment within the partnership.   Partners in an incorporated partnership typically have limited liability for the debts of the business, however there must be at least one general partner with unlimited personal liability, should the partnership be unable to meet its obligations.  Unsurprisingly, the limited liability partnerships and incorporated partnerships are not widely used because unlimited personal liability is attached to at least one partner and so tend to be commonly utilised by larger legal and accounting practices than by smaller financial services practices and accounting firms.

Partnership or another structure?

Before resolving to set up a partnership, you should first consider whether it is the best structure within which to run your business.  Importantly, you should take some advice from your taxation advisors as to what is likely to be the most efficient means of running the business.

There are other structures that may be a better fit for you, one obvious alternative is to incorporate a private company.  Clearly, if you are intending to run a business which will hold an Australian Financial Services Licence, a Credit Licence or operate as a Corporate Authorised Representative, then a partnership is not appropriate.  However, if you and a few other colleagues who are in the same field believe that it is economically more viable to share expenses and resources and you do not wish to go to the expense of incorporating, a partnership might suit your circumstances.

Your main considerations before entering into a partnership must however be:

1. can I work alongside the others in a cooperative way?
2. do I trust the others to operate appropriately, diligently and lawfully so as to not place my personal assets in jeopardy?
3. would another structure be better, safer or more cost-effective? From a personal income tax perspective, a company might be a more efficient structure, where you anticipate making a significant profit.  In a partnership, each partner will pay tax on the net remuneration received at their individual income tax rate, which can often be greater than the company tax rate.  Clearly, expert advice should be sought before a decision is made.

A company structure will limit the personal liability of its shareholders and can ensure the business will continue on after the participants leave the business by a simple transfer of shares to an incoming shareholder.  However, a general partnership may need to be dissolved when one partner resolves to retire from the business or sell his part of it, which could also give rise to tax consequences.  Importantly, a comprehensive and properly drawn partnership agreement should be able to overcome most issues relating to business succession of a partnership.

Partnership agreement

Although partnerships can certainly be set up without drafting a partnership agreement, the benefit of having a partnership agreement prepared which addresses your specific situation cannot be over-estimated.  It essentially represents the “rule-book” by which every partner must abide and upon which all may rely.  It will give certainty to the arrangements, avoid conflict and (to the extent possible) minimise exposure to personal liability.

Where a partnership agreement is not executed, the default provisions of your state or territory’s Partnership Act will apply and, although these provide, to a limited extent, a general legal safety net, it is unlikely that they will reflect the intentions, understandings and requirements of your partnership.  Accordingly, it is prudent to have in place a partnership agreement that reflects your business, partners, your circumstances and intentions.

Because of the potentially complex issues and potential exposure to personal liability, you should have your partnership agreement drafted or reviewed by a lawyer to satisfy yourself that it is tailored to your specific circumstances and is both adequate and enforceable.

There may be a misconception that having a contract reviewed by a lawyer will be cheaper than having one drafted by a lawyer at the outset.  Often they often comparable in cost.  A well-drafted contract will ensure the rights and obligations required by the parties are encapsulated in the contract.  If a tailored agreement is not considered necessary, there are sources that set out the essential elements of a partnership agreement.[3]

Dissolving a partnership

A partnership may be dissolved in a range of circumstances, for example, if there is a term in the partnership agreement that expires, a partner gives notice to exit the partnership or a partner dies.  Should one of these events occur and you want your partnership to continue with the remaining or with new partners, you will probably need to enter into a new partnership.  Unless your partnership agreement provides for admission of new partners, you will also probably need to execute a new partnership agreement.

How can we assist?

If you are considering setting up a partnership to run your business or you need advice on which structure might best suit from a legal perspective, we can provide you with advice on the options which may be available to you.  Should you decide that a partnership is appropriate, we can advise and assist in drafting a partnership agreement.  Where a company is a better option, we can also assist you incorporate a company and prepare a comprehensive shareholders agreement.

Authors: Tim Dixon (Special Counsel) and Alexa Bowditch (previously a Lawyer at Holley Nethercote)

[1] Partnership Act 1963 (ACT); Partnership Act 1892 (NSW); Partnership Act 1997 (NT); Partnership Act 1891 (QLD); Partnership Act 1891 (SA); Partnership Act 1891 (TAS); Partnership Act 1958 (VIC); Partnership Act 1895 (WA).

[2] Section 115 of the Corporations Act 2001 (Cth) limits the number of people who can form a partnership to 20, unless the partnership is incorporated.

[3] eg: QLS Partnership fact sheet.