What is a Partnership?

If two or more people run a business together but not as a company, they are operating a partnership. Many partnerships operate without a formal Partnership Agreement, meaning that the provisions of the Partnership Act will apply by default. However, entering into a Partnership Deed early on allows partners to control how the business operates, divide responsibilities, and ensure a mechanism exists for resolving disputes.

A well-thought-out Partnership Agreement helps establish guidelines on:

• The proportions of the partnership held by each partner,
• Capital contributions,
• Division of expenses and profits,
• Pre-emption rights to buy out a retiring partner,
• Provisions for partner death, insolvency, or incapacity.

Key Characteristics of a Partnership

1. Joint Liability: Each partner is jointly liable for the debts and liabilities of the partnership. This means that a creditor can recover a debt from any partner, even if the debt was incurred by another partner. However, a partner who has paid the debt can seek a contribution from the others, based on their respective partnership shares.

2. Transfer of Shares: Unlike in companies, transferring partnership shares is complex. Admitting or removing a partner effectively dissolves the existing partnership and creates a new one, resulting in higher legal and accounting overheads compared to share transfers in companies.

3. Personal Liability: Partners are responsible for any debts incurred by the business. Unlike a company structure, partners’ personal assets are at risk if the partnership fails to meet its financial obligations.

Types of Partnerships

There are three main types of partnerships in Australia:

1. General Partnership (GP): All partners share profits and liabilities equally, unless otherwise stated in the Partnership Deed. General partners have unlimited liability for debts incurred by the partnership.

2. Limited Partnership (LP): This involves at least one general partner with unlimited liability and one or more limited partners whose liability is restricted to the amount specified in the Partnership Deed. Limited partners cannot participate in the day-to-day management of the business.

3. Incorporated Limited Partnership (ILP): This special type of partnership has separate legal entity status (similar to a company). It is primarily used for venture capital purposes, where general partners have unlimited liability, but limited partners' liability is capped. These partnerships receive tax benefits under federal law.

Benefits of Forming a Partnership

• Easy Setup: Partnerships are relatively simple and inexpensive to establish compared to companies.
• Shared Management and Risks: Partners can share decision-making and the burden of running the business, which can reduce individual stress.
• Minimal Reporting: Unlike companies, partnerships have fewer reporting and regulatory requirements.
• Profit Sharing: Partners can share profits according to the terms agreed upon in the Partnership Deed.
• Taxation: Partnerships don’t pay income tax. Instead, each partner pays tax on their share of the business’s net income.

Potential Pitfalls of a Partnership

• Unlimited Liability: Each partner is liable for the full extent of the partnership's debts, even if the debts were incurred by another partner.
• Transfer of Ownership: Transferring ownership in a partnership is more difficult than in companies, as it often requires dissolving the current partnership and forming a new one.
• Disputes: Without a clear dispute resolution process, disagreements can lead to the dissolution of the partnership.
• No Separate Legal Entity: A partnership is not a separate legal entity, so the business’s obligations are directly tied to the personal obligations of each partner.

Other Factors to Consider

Partnership Agreement

A well-drafted Partnership Agreement is crucial for avoiding disputes and ensuring that all partners are aligned on their roles and expectations. The agreement should cover:

• Authority and Responsibilities: Outline the duties of each partner and their level of authority.
• Capital Contributions: Specify the financial input of each partner.
• Profit Distribution: Detail how profits and losses will be shared.
• Dispute Resolution: Establish a process for resolving disagreements.
• Exit Provisions: Define procedures for a partner’s exit from the business, whether through retirement, insolvency, or death.

Tax Requirements

A partnership doesn’t pay income tax. Instead, each partner pays tax on their share of the partnership’s income. However, partnerships with an annual turnover of $75,000 or more must register for GST.

Choosing the Right Business Structure

Selecting the right business structure depends on several factors, including liability, taxation, and how much control you want over the business. Consider the following structures when starting or expanding a business in Australia:

• Sole Trader: Full control, simple setup, personal liability.
• Partnership: Shared profits and risks, relatively easy to set up, but partners are liable for the business’s debts.
• Company: Separate legal entity with limited liability but higher setup costs.
• Trust: A trustee holds and manages assets on behalf of beneficiaries.

Conclusion

Partnerships offer a flexible way to run a business with shared responsibilities and profits, but they come with risks, especially around personal liability. It’s important to seek legal advice early on to draft a solid Partnership Agreement and to ensure you understand the implications of this business structure. Partnerships can be a rewarding way to run a business, but they require careful planning and ongoing collaboration between partners.

For more information or assistance with setting up a partnership, contact QBPL for expert advice tailored to your business needs.