Before we talk about putting together a partnership agreement for a business, we need to ask ourselves “What is a partnership?” And also: “Is a partnership the best structure for the business”?
The other commonly used business structure is a company. What’s the difference between a partnership and a company? A partnership is like a relationship. If two people get married, but then get divorced, the marriage relationship is over. There is no “marriage entity” that exists independent of the two people involved. New spouses can’t come in or leave, from time to time. In exactly the same way, if one partner leaves, the partnership finishes.
This is how the traditional form of partnership functions. There are some twists to the story. One is that in many countries (including Australia, where I practise law), the taxation authorities will regard partnerships as continuing entities for taxation purposes even if a partner leaves or joins, although, strictly speaking, as a matter of law the existing partnership has dissolved and a new partnership has been formed. Another twist is that in some countries there are things called “limited partnerships” and “limited liability partnerships” (LLPs), which have special rules. LLPs have features that are more like companies. (LLPs can’t be created in Australia at the time of writing, but LLPs created elsewhere can do business in Australia.)
One extra point: it is also possible, in lots of countries, for companies to form partnerships with each other, or with individual persons. In that situation, if the partnership dissolves, the member entities continue existing as before, unaffected.
Therefore, if you want to create a partnership, it is smart to do that in writing via a partnership agreement. This agreement will define what the partners put in, what they get out, how new partners can join, what happens if any partner leaves, how decisions are made, and how the partnership can be closed down, to name a number of the key topics. (Not a complete list.)
In contrast, a company does survive the coming and going of its members (shareholders). It exists independently of its members as a legal entity. Companies also have member agreements, usually called “shareholder agreements”, that cover much the same ground as partnership agreements.
Why choose one structure over the other? This depends on a number of issues. One of these is taxation: it may be better, for tax purposes, to have a partnership than a company, or vice versa, depending on the situation. Companies have limited liability. It may be best to choose the company structure for that reason. It is important to compare the pros and cons of each type of structure carefully, before making a choice.
[If you would like to find out if your business should have a partnership agreement or a shareholders agreement, and would like legal advice on setting up your business structure, please contact us. The author of this blog post, James Irving, is a commercial lawyer in Perth, Australia, who has many business owner clients. Photo credit: Office Center EXPO Plaza, Hannover, by ASP Architekten Schneider Meyer Partner, a public domain image courtesy of Wikimedia Commons, CC BY-SA 2.0 DE.]