What Is the Right Business Partnership for You?
When you’re starting a new company, you can either form a business partnership or try growing your business alone by becoming a sole trader. If it’s not the latter, then it’s vital for you to understand the various types of business partnerships that exist in order to decide which one will be most suited to your entrepreneurial goals.
A Business Partnership Defined
Section 1 of the Partnership Act 1890 defines a partnership as: “The relation which subsists between persons carrying on a business in common with a view of profit”. At least two persons comprise a partnership and each “person” can either be an individual or another legal entity such as a limited company (classed as a “person”).
Note:When one partner ceases to exist (e.g. due to individual death/company demise), and subsequently there is no longer at least two individuals/entities in the partnership, then the partnership will automatically become dissolved. The remaining partner can then choose to become a sole trader, begin the process of limited company formation, or continue to create a new partnership. When it comes to forming the latter, it’s vital you understand the different types of business partnerships and what each of them entail, as defined below:
What Is an Ordinary Partnership?
Most business partnerships are considered to be “ordinary partnerships”. This is where a group of two or more persons carry out business duties collectively; each individual partner must act on behalf of the other partner(s) when contracts are negotiated with third parties.
Additionally, each partner is liable (jointly and separately) for any business debts. They must also, without limitation, fulfil company obligations of a partnership as a whole.
Note: If the partnership is sued, each partner can be individually pursued by a debt-recovering creditor.
Each partner is responsible for owing the other partner any fiduciary duties, including an undertaking to the following:
- Rendering accounts and full details regarding the partnership (section 28 Partnership Act 1890)
- Accounting for any personal profits gained during the course of the business partnership (section 29)
- Not competing with the business partnership without the consent of other partners; subsequently handing over any profits generated (section 30)
Many partnerships will often have a partnership agreement in place. The agreement outlines the various rights, responsibilities and duties of each partner including:
- Explanation of any bespoke split of profits
- The decision-making process
- How to follow correct procedure in case a partner leaves the company
What Are the Pros and Cons of an Ordinary Partnership?
Pros: Since an ordinary partnership is not incorporated, there are fewer administrative tasks and costs involved, such as “annual filings”. Moreover, since company accounts are not required to be published or made publicly available, your competitors won’t have immediate access to information that they could use in their favour.
Cons: Each partner is personally liable for debts incurred by the partnership. Additionally,
the partnership does not have its own legal identity and therefore cannot trade or borrow finances on its own account.
What Is a Limited Liability Partnership (LLP)?
In 2001, a Limited Liability Partnership (LLP) became a new form of legal entity introduced to the UK as per the Limited Liability Partnerships Act 2000. Essentially, LLPs are structural combinations of both ordinary partnerships and private limited companies, enjoying the advantages of both types of business partnerships.
In contrast to traditional business partnerships, an LLP is an incorporated company and considered to exist as its own legal “person”. LLPs can own assets and borrow finances independently.
As a partnership-requisite, all LLPs must also include at least two persons (known as “members”). Although there can be any number of ordinary members, LLPs require a minimum of two designated members who will hold the following responsibilities:
- Completing the VAT-registration for the partnership if the annual turnover is expected to exceed £85,000
- Appointing an auditor (if required)
- Maintaining all accounting records
- Preparing, signing and delivering annual accounts to Companies House
- Sending confirmation statements to Companies House
- Keeping Companies House up to date with necessary administrative information
- Acting on behalf of the LLP if it is wound up and dissolved
Similar to an ordinary partnership, any profits made by an LLP will be distributed to partners who in turn are responsible for paying their own personal income tax.
The incorporation process of a Limited Liability Partnership is pretty similar to that of a limited company:
- Choose a unique name that is not similar to other registered company names. It must end in “Limited Liability Partnership”/ “LLP” (or the Welsh equivalent).
- Have a registered address to which official correspondence will be sent. This needs to be an actual physical address located in the same country in which the LLP is registered. A P.O. Box may be used but still has to be followed by a physical address. (The registered address will be publicly available).
- Register the LLP electronically using third party software, or via paper/post. Use form LL IN01, or a reputable company formation agent.
- Specify at least two designated members.
- Consider forming an LLP agreement (similar to a shareholders’ agreement) outlining the desired running of the LLP.
What Are the Pros and Cons of a Limited Liability Partnership?
Pros: A major advantage of forming an LLP is that its members/partners are not personally liable for any debts incurred by the partnership. Furthermore, unlike in an ordinary partnership, fiduciary duties are generally not owed between partners, each partner owes them to the LLP.
Cons: You must disclose the details of all the important duties of running an incorporated company, such as annual filings. Additionally, all income must be disclosed.
What Is a Limited Partnership (LP)?
Limited partners (LPs) are often known as “sleeping partners” — investors who choose not to take an active part in the running of a business. At least one of the partners in an LP has to be a “general partner” (non-limited partner), meaning they have unlimited liability.
Nowadays, an LP is not a common type of business partnership, although they have been in existence since the Limited Partnerships Act of 1907. Moreover, an LP is not an incorporated company structure and has no legal status of its own.
Individual partners must maintain responsibility for entering into contracts on behalf of other partners. However, in an LP it is acceptable to designate specific partners as “limited partners” who are inactive in the management of the partnership and, importantly, have limited liability (limited to their capital contribution) for any debts incurred by the partnership.
What Are the Implications for Profit, Loss, and Tax?
Unless agreed otherwise, profits and losses are shared out equally between all partners. In an ordinary partnership (not in LLPs and LPs), all partners are jointly and severally liable for all company debts and liabilities of the respective partnership.
Each partner is responsible for paying their income tax in relation to their personal share of profits and expenses — no tax is levied upon the partnership itself.
What Is a Partnership Agreement?
A partnership/LLP agreement is highly encouraged. The agreement will outline the rules under which the partnership/LLP will operate and include issues such as:
- Capital contribution of partners and profit share
- Management of partnership and the decision-making process
- How to process and handle the exit of a partner
- Defining partner responsibilities (to both one another and to the LLP)
When deciding to set up a partnership, you essentially have two main options: an ordinary partnership and a Limited Liability Partnership.
Additionally, it’s vital to have an agreement in place as a comprehensive and effective partnership agreement will enable the smooth running of a business and can help resolve any potential disputes. If there is no LLP agreement in place, the Limited Liability Partnerships Regulations 2001 lists “default provisions” to govern specific aspects of running an LLP.
For help with deciding between the various types of business partnerships available, or for any related assistance, contact our reputable team and launch your business address, today.