Summary
- Choosing between a general partnership, a limited liability partnership (LLP), or a private company limited by shares affects your legal liability, tax obligations, flexibility, and ability to raise finance.
- General partnerships offer simplicity but expose partners to unlimited personal liability, whereas LLPs and companies provide greater protection.
- A shareholder agreement or partnership agreement is essential for setting out each party’s rights, responsibilities, and profit-sharing arrangements clearly.
- This article is a plain-English guide to business structures for Australian business owners considering entering into a partnership or incorporating a company.
- It has been prepared by LegalVision, a commercial law firm that specialises in advising clients on business structures and corporate law.
Tips for Businesses
Before choosing a business structure, consider your liability exposure, how profits will be shared, and your plans for growth. Document all agreed terms in a partnership agreement or shareholder agreement. If raising external finance is a priority, a company structure may be more suitable, as partnerships cannot issue share capital.
Are you interested in going into business with another person, such as a friend or family member? Are you wondering what the best way to structure this relationship is? Is a business partnership more effective than forming a company? This article explains the key differences between companies and business partnerships, including their advantages and disadvantages, to help you choose a business medium that is right for you.
Overview
Different sets of laws govern partnerships and companies.
There are two primary forms of business partnerships:
- general partnerships; and
- limited liability partnerships (LLPs).
In partnerships, the partners share in the profits and the losses of the business. Each partner has broad authority to act on behalf of the partnership. While many partnerships split profits and losses evenly, some partners can receive more profits than others. This will be based on the partnership agreement between all the partners. Likewise, the partnership agreement will specify the extent of each partner’s powers and responsibilities. Often, a business started by two or more people will begin as a general partnership, as it does not require any formal registration. However, with a lack of clear rights and responsibilities for each partner, it is best to formalise this in a partnership agreement or consider changing to an LLP or a limited company structure.
We will now go on to consider the legal definition of:
- general partnerships;
- LLPs; and
- private companies limited by shares.
Partnerships
In both general partnerships and LLPs, the partnership agreement sets out the rights and obligations between all the partners. There is no legal requirement to have a partnership agreement; however, it is best practice to do so.
- how profits and losses will be split;
- processes allowing for the retirement of partners and the appointment of new partners;
- the power of the partners to act on behalf of the partnership; and
- how to remove partners from the partnership.
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General Partnerships
The law recognises general partnerships automatically if you and your partners carry on some business activity and share in the profits and losses.
General partnerships are not capable of existing as incorporated entities or as separate legal personalities from their partners. This means that your partnership:
- cannot own property in its name;
- cannot enter into contracts in its name; and
- cannot defend itself in the event of any dispute.
This means that each partner will be responsible for the partnership’s actions and the other partners. So, for example, if the partnership cannot pay a debt or is sued, the partners themselves will be held personally liable. This is the most significant risk a partnership faces: partners may need to sell personal assets (e.g., their home) to pay off the partnership’s debts. Partners will also need to pay income tax on their share of the profits generated by the partnership.
What Happens If There Is No Partnership Agreement?
If you and your partners start trading without a formal agreement, the Partnership Act 1890 fills the gaps. This means the law automatically applies default rules to your partnership.
For example, profits and losses are split equally, regardless of how much each partner contributed. Every partner also has equal say in business decisions. These default rules may not reflect what you and your partners actually want.
Disputes can arise quickly when expectations differ but nothing is written down.
A written partnership agreement lets you override these defaults and set your own terms. It does not need to be complex, but it should cover profit sharing, decision-making, and what happens if a partner wants to leave. Without one, resolving a dispute becomes harder and more expensive.
LLPs
LLPs do not arise automatically. Instead, you must create the LLP by filing certain documents with Companies House to register the LLP. The law refers to each partner as a “member”, and they will collectively ensure that the LLP keeps up to date with its Companies House obligations, such as filing its annual accounts. The LLP structure is particularly popular among professional service firms, such as accountants and solicitors.
This means that, in the event the LLP cannot cover its debts, the liability of each partner will not be unlimited, unlike in a general partnership. If a partner acts in an improper way or outside the scope of their powers as a partner, under an LLP, you will generally not be personally liable for their mistake, though the partnership itself will have to account for the errant partner’s error.
Private Companies Limited by Shares
A large portion of companies are private companies limited by shares. Ownership in a company is determined by how many shares you hold in the company. This provides more flexibility when different parties have contributed varying amounts to the company.
If you want to ensure that each member (i.e., shareholder) has the same rights to share in the profit (i.e dividends declared by the company), each shareholder will need to be issued the same number of shares and have each “class of shares” be the same.
The company structure is less flexible when specifying other matters, such as the amount each member of staff should work. For instance, you cannot simply specify this in your company’s constitutional documents, including its articles of association, because these documents only apply to rights and obligations owed by the shareholders as shareholders. You cannot try and create private obligations between each shareholder in their capacity, such as each partner’s right to serve as a director.
You can create a “shareholder agreement” that will practically give effect to the same terms you might specify in a partnership agreement. This is because the shareholder agreement is a private document between each shareholder in their personal capacity.
Comparing Partnerships and Companies
In determining which business structure is suitable for you and your business partners, there are a few key things to consider:
- do you want to benefit from limited liability?
- how flexible do you need the relationship between you and your partners to be?
- do you have any plans to admit new members to the business?
- how much administrative burden are you and your business partners willing to shoulder?
Generally, general partnerships and LLPs offer more flexibility than companies and require less administrative effort and disclosure of financial records, especially in the case of general partnerships.
On the other hand, companies are more common. It can be easier to raise capital because much of corporate finance is based on using a company’s share capital, especially when raising equity finance. However, LLPs can still borrow money much the same way companies can.
In general, if you want the rights and obligations of each partner to be the same, you can easily set this out in the partnership agreement of either an LLP or a general partnership. However, achieving the same effect under a company structure requires more steps.
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Key Takeaways
If you want the rights and obligations of each partner to be the same, you can easily set this out in the partnership agreement of either an LLP or a general partnership. Achieving the same effect under a company structure requires more steps. Companies do have inherent benefits, particularly in terms of the legal and commercial importance of share capital when raising finance. Neither general partnerships nor LLPs are capable of having share capital. Therefore, before entering into a partnership agreement or incorporating a company, you and your business partners should consider obtaining legal advice on which structure and under what terms works best for each of you.
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Frequently Asked Questions
Fundamentally, business partnerships and companies operate under different legal mechanisms. For instance, the owners of a general partnership are called “partners”, whereas, under a company, they are called shareholders. Practically, either business structure can give effect to specific agreements you and your business partners want to enter into, though this will likely require legal advice.
In short, by default, a general business partnership will automatically grant each partner the same rights and obligations as the others, as the law implies equality among all business partners absent any express agreement to the contrary. In other words, you and your business partners could start trading, and as long as you have not done anything that indicates otherwise, the law will assume everything is equal between you.
No. A general partnership has no separate legal personality, so it cannot own property, enter contracts, or defend itself in disputes in its own name.
Yes. Each partner pays income tax on their share of the partnership’s profits.
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