Do I Need A Partnership Agreement For A Small Business?

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If you’re running a small business, undertaking self-employment, and don’t want to go as far as to create a separate legal entity for it (a “company”), then there are two options for you; you can operate as a sole trader, or you can enter into a business partnership with one of more other people.

A business partnership is a fairly simple arrangement. Both yourself and your business partners (there can be more than two) are jointly responsible for everything that happens in the business.

In other words, each partner is personally liable and responsible for any losses or damages that were done by the business, and conversely, they share in the profits.

4 Benefits of Partnership Agreement For A Small Business

Do I Need A Partnership Agreement For A Small Business

The benefits of business partnerships are quite straightforward and include:

1. Cheaper to Set Up

They’re cheaper to set up, as you don’t need to go through the expense of setting up a business entity, setting up trusts, or paying wages. Consequently, there are minimal administration costs to worry about.

2. Work Immediately

You can get to work immediately. You don’t even technically need to get the business arrangement written down on paper (though for obvious reasons it’s a good idea to do so anyway).

3. More Than a Sole Trader

You can do more than you’d be able to as a sole trader. Your business partner may have different skills and abilities to yours, and therefore, combined, your work would be that much more effective.

For example, you might be good at using technology to create innovative products, while your partner excels in developing marketing campaigns and strong customer relationships.

4. Avail Tax Benefits

There are tax benefits, too. Because you split the profit from the business across multiple people, you can find yourself in a lower tax bracket.

Splitting $700,000 in profit across a partnership of four people results in a far lower tax than setting up a company that makes $700,000 and pays that out in wages to its four employees.

Disadvantages of Partnership Agreement in Small Business

However, there are also a number of disadvantages that you need to be aware of, including:

1. Insolvency in Partnership

When in a business structure, you can be protected from the actions of other people working in the business. If one of the partners in the business becomes insolvent, the other partners are responsible for reparations for the damage caused, and this can affect their personal wealth, rather than just their company’s assets. As such, this is considered to be a business model that has a high degree of personal risk attached to it.

2. Emotional Complexities

There’s also the emotional complexities. Partnership agreements are generally between family, but many people fear to enter a partnership agreement precisely because the pressure of business can affect those bonds… particularly if something were to happen to leave some of those in the partnership liable for damages caused by others.

3. Decision Making Power

Some people may also struggle with the lack of autonomy that comes with working in a partnership, as you have to share control over all business decisions. This is particularly an issue if you’ve previously operated as a sole trader and struggle to relinquish control, which can lead to conflict.

How to handle a business partnership

While it’s generally a good idea to set up a company, rather than a business partnership, for many small businesses that can still seem like overkill, even with the advantages that the company structure offers.

If a business partnership is a way to go, it’s still a good idea to speak to a lawyer or hire a general council and have a proper agreement set up, which will outline the following:

–          What each partner will contribute financially?

–          How profits and losses will be managed?

–          The obligations and rights that each partner will have in the business

–          How disputes will be resolved?

–          The length of time that the partnership will last

–          Exits – how partners can exit the partnership, and what happens to the business if they do

While all partners will continue to be liable as per the law, having a formal, legally-drawn agreement is an important step in protecting the partnership business and mitigating the risk that emotions get involved in the operation of the business.

Having a formal agreement in place can also help to smooth the transfer of the business and its assets in the event that one of the partners passes away (this is covered under the “exit” clauses).

Without it, even with a properly drafted will, establishing and proving the nature of the partnership business can become a drawn-out process that will likely cost you time and money.

Business partnerships, though often considered “archaic” do still remain appealing for the smallest “mom & pop”-style businesses. The minimal reporting requirements to the ATO help alleviate the regulatory burden, and unlike a sole trader, a business partnership can still employ staff and can grow in size (by adding more partners to the business over time).

You need to be able to trust your business partners and be sure that they’ll pull their weight to contribute to the business while not taking risks that the others in the business don’t have the appetite for.

The biggest problem that partnerships face is the liability exposure that all partners share – when things go really wrong, the entire organization, and every one of the partners can suffer.

It’s always a good idea to talk to properly qualified lawyers to determine what is the ideal structure for your planned organization. They will walk you through the pros and cons of each, and how they might apply to your situation and benefit your business idea, now and into the future.

Author Bio: Sam Want