Trading as a Partnership – Does it still work?
Average read time: 5.5 minutes.
Most areas of law are constantly evolving with new pieces of legislation being enacted at regular or irregular intervals. Partnerships, on the other hand, have been regulated by the same piece of legislation since 1890, namely the Partnership Act 1890 (Act).
Here we ask whether the Act, some 130 years on, is still relevant. Are partnerships still a sensible structure for some businesses to use, and what are the advantages and disadvantages? Why has there been such nominal change?
Partnerships do not have distinct 'Legal Personality'
A partnership is defined by the Act as 'the relation which subsists between persons carrying on a business in common with a view of profit'. The key feature of a partnership is the people involved and the relationship between them. Unlike a limited company, for example, a partnership does not have a separate legal personality from its partners, i.e. the partnership is not distinct from its partners.
In practice this means that a partnership cannot own property or other assets in its own right, nor can it create security over such property or assets. Instead one or more of the partners must hold property and other assets on behalf of the other partners in partnership. This is something to consider if the business is likely to be entering into a significant number of commercial contracts or financing arrangements.
Partners do not benefit from Unlimited Liability
In keeping with this key principle that the partnership business and the partners in business are one and the same is the unlimited nature of the partners' liability. An incorporated organisation, for example a limited liability partnership (an LLP) or a company, has a separate legal personality from the individuals that stand behind it. If the business of an LLP or a company fails for any reason, its creditors should only have recourse to the assets held by that distinct entity; they cannot come after the individuals behind it. The position is different in respect of a general partnership: if a partnership encounters financial hardship, its creditors can come after the individual partners (and their personal assets) in order to meet the debts and liabilities of the partnership.
This does not seem ideal: you do not want your house to be on the line because of unfortunate or ill-judged business decisions. Is this, however, hugely different to a director of a private company providing a personal guarantee when applying for a business loan? Or a shareholder permitting a charge to be created over their shares as security?
What are the Advantages of a Partnership?
There are real advantages in a partnership. Partnerships are treated as transparent for most tax purposes. This means that the activities of the partnership are treated as activities of the individual partners (because of the absence of any separate legal identity) and are not subject to corporation tax.
Let's take two identical businesses operating at the same time and as successfully as one another. The first is an incorporated company and the second is a partnership. The first will pay corporation tax on its trading profits and then, when the profits are taken out of the company by the individuals involved, either by way of director remuneration or shareholder dividend, income tax also becomes payable. The profits of the partnership are, however, only taxed once in the hands of the individual partners.
This is, of course, an oversimplification. There are tax-efficient ways to structure an incorporated business so that income, when taken out, is done so as tax effectively as possible. But in simplistic terms the profits of a partnership are only subject to one type of tax liability.
Another great advantage of a partnership is the privacy that it affords the individuals involved and its business. Unlike a company and an LLP, a partnership is under no obligation to file statutory accounts and other business sensitive information at Companies House. This has significant cost and privacy benefits. The partners can choose the business information that they want to be in the public domain (if any).
This lack of publicity must be key in the continual take-up of partnerships. Many of the partnerships that we see are family-run businesses, particularly in the agricultural sector, and it is entirely understandable that a family business would want to keep their financial standing private.
The absence of any real filing requirements and minimal regulation also allows a huge amount of flexibility: partners are free to regulate the affairs of their business between them.
Is trading as a Partnership still viable?
So, are partnerships still a sensible business solution for some? Yes. For the reasons set out above, partnerships are still a sensible business solution for many people.
And why has there been such nominal legal change? Because the Act continues to work. Increasing regulation could defeat the key advantages of a partnership and complicate an area of business law that has operated smoothly for well over a century.
So, can anyone set up a partnership? Yes, but be wary: without a clearly worded partnership agreement there are risks. Individuals establishing or joining an already established partnership will be investing in the business in terms of real assets and/or in terms of their time and they will want to know (or should want to know) the return on that investment. How will profits be split? How will managerial decisions be made? What if they want to introduce or block a new partner? Bottoming out all of these issues at the outset will not only reduce the likelihood of a fallout at a later date but will also highlight early on what the issues between the partners are likely to be (if any). This is particularly important in a business where the liability of the individuals is unlimited.
Sadly, it is not unusual for us to see relatives in dispute with one another because of the absence of a clear and fitting partnership agreement. Parents, for example, often make statements about the division of a family partnership that their children then rely on. If these statements are not reflected in an up to date partnership agreement, costly disputes can arise on the death of the parents.
Spending a bit of time getting a sensible partnership agreement drawn up will save hours of time and heartache later if there is a dispute.
If you would like a free checklist of the key issues to consider when joining an existing or establishing a new partnership, or you would like to discuss any of the issues raised in this article, please do not hesitate to contact Chloe Vernon-Shore.