Partnerships are historically one of the most common forms of business structures, appealing to many because they are generally flexible and easy to establish. Even though they are simple, a partnership is still a legal structure, and there are several factors to consider when deciding if it is the right fit for your business. This article summarises the key features of partnerships, including how they operate and the inherent advantages and disadvantages of this business structure.
What is a Partnership?
Each state/territory in Australia has its own legislation setting out the law relating to partnerships. In NSW, this is the Partnership Act 1892 (NSW), and in the ACT it is the Partnership Act 1963 (ACT). This means that the formal requirements of a partnership can differ from jurisdiction to jurisdiction, but generally a partnership requires:
a) A valid agreement between the parties (preferably but not necessarily written);
b) The carrying on of a business in common (meaning the parties have a mutuality of rights, interests, and obligations); and
c) That the business is operating with a view to profit.
It should be noted that outside of the legislative framework, partnerships can also exist within the common law despite not meeting the above formal requirements.
Types of Partnership
The two most common forms of partnership are ‘general’ and ‘limited’ partnerships. Partner liability is typically the most material concern in deciding on which type of partnership to establish.
General partnerships are more popular than limited partnerships and function so that all partners are equally responsible for the management of the business. This means there is unlimited liability for the debts and obligations of each of the partners. Partnerships are also taxed differently than companies, with partners (rather than the partnership as a separate entity) pay tax at their individual marginal tax rates. This means any losses can be offset against a partner’s other income streams.
Limited partnerships are typically made up of both general (unlimited liability) partners and limited liability partners. Liability is limited for some partners through the nature of their investment within the partnership. Limited partners typically have less liability for any debts of the partnership (usually capped at the capital they invest or contribute to the venture) and have a more passive and non-managerial interest in the partnership. They may benefit from profits, but are likely to have less control over the direction of the business and do not have authority to bind the partnership to contracts or decisions. Limited partnerships tend to be taxed more similarly to companies, although some features of their taxation better reflect that of a general partnership, particularly in the European Union and the United States.
Another less common form of partnership is the incorporated partnership, which is sometimes used by larger firms. Under this model, unlimited liability attaches to some but not all partners, and the business may be subject to more company-like compliance measures including increased regulatory obligations. These partnerships also need to be registered with appropriate corporate regulators.
Advantages of Partnerships
Partnerships are easier to establish than companies and usually have lower ongoing administration costs, due to fewer regulation and compliance obligations. This makes the structure ideal for small or medium-sized enterprises that have limited administrative resources.
The multi-person setup of partnership can make the structure safer than sole trading, with expertise, resources, decision making, and liability shared between partners. The exact split of these responsibilities can be determined by the partnership agreement that governs the relationship and reflects the needs of the business, making the partnership structure highly flexible. Subject to the partnership agreement on foot, obligations for decisions to be made jointly (or even unanimously) can provide protection for the operation of the business. However, a cooperative structure can also be cumbersome when it comes to contentious future decisions, such as those in relation to expansion or investment.
Partnerships are generally considered a higher-risk structure than a standard company structure. This is because partners share profits and losses and can often face high levels of personal liability because, unlike companies, partnerships have no separate legal identity. Yet as outlined earlier in this article, liability risk does differ depending on whether the individuals are in a general partnership or a limited liability partnership.
Partnerships also have a ceiling on growth. Under the Corporations Act 2001 (Cth), partnerships can support a maximum of twenty partners, with a number of exceptions (e.g. legal practitioners may have up to 400 partners, accountants up to 1,000 partners, and medical practitioners 50 partners). Therefore, partnerships have limited capital raising and growth potential. Partnerships are also susceptible to breakdowns in relations, and depending on the drafting of a partnership agreement such breakdowns could result in dissolution of the partnership structure.
One other key factor to consider is the nature of the partners’ relationships to each other. Partners owe each other fiduciary duties to not make unauthorised profits arising from their position as a partner, and not to take on duties that conflict with the best interests of the partnership without permission from other partners.
Operation and Governance
Most partnerships are primarily governed by a partnership agreement. Although a written agreement is not necessary to create a valid partnership under the legislation, it is strongly recommended as such agreements create clear boundaries. Those boundaries include but are not limited to: identifying which partner owns what portion of the assets; what happens in the event a partner dies or is incapacitated; and provisions surrounding dissolution of the partnership. Without formal agreement, these matters can be a source of conflict and uncertainty.
Subject to the terms of a partnership agreement, grounds for terminating a partnership can also be flexible. Some partnerships set an expiration date, based on either an end date or an event that signals the conclusion of the venture. Partnerships may also end when one partner signals their intention to exit, or partners might be forcibly removed via expulsion under certain conditions such as a material default of their performance obligations. The end of a partnership may have significant tax implications, so clarity over circumstances that result in termination can be key to a successful operation into the future.
Partnerships can be a flexible and simple, yet effective business structure. Whether one of the various forms within this structure is the best fit for you depends on many factors, including the nature, size, and potential for growth of your business.
If you have any questions about partnership structures or would like to better understand your busines structure options, please contact the team at Hazelbrook Legal.
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