Forming a mutually beneficial business partnership is often an attractive idea. There can be plenty of sound reasons for entering into a business arrangement: you may want to pool your capital and resources, or perhaps you’d just like to have someone else to share the workload. That said, however in-sync both parties feel now, things may not always be this way.
Plans, priorities and trading conditions can change; it’s one of the realities of running a business. Sometimes this means bringing a partnership to an end. If you are just about to enter into an arrangement, or are in one already, it’s important to recognise this. It pays to ensure you, the business, and your assets are in safe hands if circumstances change. Here, we’ll explain what is involved in this process — so that the end of a partnership doesn’t mean the end of the world.
What are the risks in a business partnership?
Even in the closest of professional relationships, you can never discount the possibility of a messy disagreement. It could range from a difference of opinion over the future of the company, to how profits should be shared and allocated amongst you. Often, partnerships organically come to an end for much less dramatic reasons; one of you may want to seek out a new challenge, personal circumstances might change, or you may simply decide that it’s time to retire.
This poses potential risks to the outgoing partner, as well as to the remaining partners and the business in general. If it’s unclear who owns what, there is the possibility of a drawn-out dispute and one or more of you getting shortchanged. What’s more, if the end of the partnership means disposing of business assets, such as working capital or property, it can become seriously difficult for the business to continue to function.
With that in mind, it makes practical sense to have an idea of what should happen if your partnership ends.
The partnership agreement and asset protection
Legally, a partnership consists of two or more individuals working together with a view of making a shared profit. A written agreement isn’t a legal requirement for a business partnership; however, for practical purposes and protecting your interests, it is essential.
Agreements like this can actively help reduce the chances of a dispute arising in the first place. A well-drafted document will set out the terms of the relationship. This will include: how profits will be shared between the parties, the allocation of each partner’s day-to-day responsibilities, and what happens when a partner needs to leave. With all of this agreed and clearly defined, there is less scope for conflict stemming from misunderstandings. In other words, there’ll be no assumptions regarding the outcome of going solo as the consequences will have been made clear from the start.
If you have already started trading in a partnership, it’s never too late to draw up an agreement. In fact, it’s highly recommended. Each partner should consider obtaining independent legal advice in connection with this. The end result should be a document that accurately defines your agreement as well as safeguarding both parties’ interests and assets.
Asset protection in practice
When protecting your position in a partnership, avoid informal arrangements with no documentation to back them up. When the position is unclear, it creates scope for one or more of your partners to exploit the situation. This invites the opportunity for someone to paint an inaccurate picture of what was actually agreed.
Let’s say, for instance, that you agree to take on the majority of the day-to-day running of your business, with your partner taking more of a backseat role. It’s understood that once the business starts to make a profit, your share will be larger to reflect all your hard work.
But without written proof, who is to say that this agreement was reached?
The law governing partnerships (The Partnership Act) states that each partner is entitled to an equal share of the profits. This is unless it has been agreed beforehand. If you have agreed on a different split, this needs to be clearly defined in the partnership agreement. This avoids disputes further down the line.
Likewise, one individual might contribute a greater capital share to the business than the others. This should be specifically referred to in the document. The partnership agreement should be seen as a ‘living document’: it needs to accurately reflect how much capital and other resources each party has contributed to the business, at all times.
Are both parties liable?
Unless your partnership is a formal limited liability partnership, it is not a distinct legal entity in the same way as a company. All partners are jointly liable for the debts and obligations of the firm. It means that if your partner acts negligently in the course of the business and a customer seeks compensation, you could potentially be facing a claim. This may put your personal assets under threat. Especially if you provide a service. It is one of the reasons why professional indemnity insurance can be so useful. Forming a limited company is another potentially beneficial way forward. This is because it draws a clearer line between ‘personal’ and ‘business’ assets.
So what happens when one of you wants to cash out and the others do not? It’s highly advisable for the agreement to contain a ‘right of first refusal’ for the remaining partners. This is so you have the chance to buy out the person who is leaving. You don’t want to be left in the lurch when it comes to locating finance or finding replacement manpower. This means it’s worth insisting on a reasonable notice period. Requiring six month’s notice, for instance, provides valuable time for the remaining party to make the necessary changes. This ensures they’re not scrambling to reorganise.
Some shared assets, such as the ‘goodwill’ built up by the business and the value of its name, require a specialist valuation to ensure no party is left out of pocket. This is why it is wise to pre-select a firm of accountants to independently value the firm. This should also be included in the agreement as a dispute resolution clause. It can certainly go a long way in resolving deadlocks and disputes.
Is a partnership still the right model for your business?
For a side-by-side comparison with other types of company formation and further guidance on structuring and restructuring, have a read of our company formation guide about company structuring, or head on over to our help centre.